Brazil: Inflation and rates expectations move higher

Brazil: Inflation and rates expectations move higher

Inflation expectations pick-up. The latest weekly survey of market consensus forecasts brought upward revisions to inflation expectations across all horizons. Expectations for 12-month-ahead inflation increased 10bp to 5.29%. Expectations for the calendar year of 2011 increased by 16bp to 6.31% Dec/Dec, mostly in response to the surprisingly higher reading on June IPCA released last week. But the median consensus forecast for 2012 also increased, up by 10bp to 5.20%. Top-five forecasting institutions revised higher their forecast for 2011 to 6.19%, up 7bp, while maintaining at 5.30% their estimate for 2012.

Consensus projections remain above the official target centre of 4.5%, although below the 6.5% target ceiling. Nevertheless, consensus continues to move projections higher closer to the ceiling of 6.5%.

As for other variables, the main highlight is higher expected policy rate. On monetary policy, the median consensus forecast for the policy interest rate for end-2011 was raised from 12.50% last week to 12.75%, now incorporating an additional 25bps hike. That implies a year-end policy rate 50bp above today's actual level. The consensus view for the end-2012 policy rate was unchanged at 12.50%, but the consensus for the average rate in 2012 was higher, moving from 12.50% to 12.69%, showing more analysts expect higher rates in 2012. On the activity side, expected real GDP growth was unchanged at 3.94% for 2011, and 4.10% for 2012. The median consensus for the 2011 trade balance was stable at USD 20.0 billion.

Our own view remains more cautious than consensus on the growth-inflation trade-off. In our opinion, inflation is a bigger challenge than the authorities are willing to admit. Something has to give. Either the economy will have to face a more pronounced downturn in order to open up sufficient slack (our view), or else inflation will prove more stubborn than the consensus view seems to expect. Looking ahead, headline near-term monthly inflation readings are set to look benign, helped by seasonal factors.

However, prospects for medium-term underlying inflation trends remain challenging, in our view. After all, the economy has been operating beyond capacity, labour markets are tight, prospects for wage pressures look challenging, services price inflation is elevated, and there is still work to do in order to guide inflation expectations back to target. In our opinion, inflation concerns will force more monetary tightening and require softer growth than the consensus view expects. The above-mentioned revisions in inflation and rates expectations were basically a move closer to our scenario.

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