News & analysis

The publication of the Brazilian National Consumer Price Index (IPCA) data for May confirmed our suspicions that disinflationary progress is set to slow, leaving the BCB at risk of pausing its easing cycle earlier than anticipated.

Not only did headline inflation increase in May compared to the previous month, rising from 3.69% to 3.93% YoY, but the underlying pace of price growth was also surprising. Printing at 0.46%, headline inflation exceeded expectations and has accelerated for two consecutive months now. This upward reading validates the decision by the Brazilian Central Bank back in May, where policymakers decided to slow down the pace of monetary easing with a cut of 25 basis points, reneging on its previous forward guidance of a 50bps cut. At the time, this decision was finely balanced.

On the one hand, aggregate inflation had continued to decelerate, which supported the BCB’s previous guidance. On the other, still high services inflation, deteriorating external inflation conditions and fiscal developments posed heightened risks of inflation persistence.

The emphasis on the upside risks, which have been realised in May’s inflation report, ultimately led the majority within the Copom to bring forward the timeline to slow the pace of monetary easing. With today’s data confirming the upside risks to inflation and BCB Governor Campos Neto recently emphasising further upside inflation risks in the form of de-anchoring inflation expectations, we suspect the BCB will continue in this vein, holding the Selic rate at 10.5% next week. Our conviction in this view is further supported by the degree of uncertainty around fiscal policy, where a vote is set to take place in June on a bill that includes reforms on consumption tax, which will have direct implications for the path of inflation.

Annual measures of core and headline inflation begin to rise, while underlying momentum should also rise again once March’s data drops out of the calculation

Turning to the data, headline IPCA stood at 0.46% in May, 0.08 percentage points above April’s rate of 0.38% and 0.15pp above the 12-month average. On a year-on-year basis, headline inflation accelerated to 3.93%, last month from 3.69% in April, beating expectations of 3.88%. According to the note accompanying the data, eight of the nine product and service groups surveyed recorded price increases last month, with household goods the only exception. Among them, the largest variation came from the Health and Personal Care group, with a month-on-month increase of 0.69% and a contribution of 0.09 percentage points to the overall index, followed by Food and Beverages (0.62%) and Housing (0.67%) which recorded the largest contributions to the overall HICP, with an impact of 0.13 and 0.10 percentage points respectively. Although IBGE does not give a specific reading of the advance in core services inflation, the rigidity of the data for Health and Personal Care (+0.69%), Transport (0.44%) and Personal Expenses (0.22%) continue to reveal upside inflation risks through persistent core services inflation given the context of labour market rigidities and fiscal transfers.

Indeed, in its latest forecast revision, Copom acknowledged these risks by revising upwards its baseline scenario for inflation from forecasting 3.5% and 3.2% for 2024 and 2025, respectively, to projecting price growth of 3.8% this year and 3.3% next year.

Expectations of higher inflation aren’t isolated to the BCB either. The latest BCB Focus Survey saw independent economists revise up their inflation expectations for this year from 3.76% a month ago to 3.9% and next year from 3.66% to 3.78%.

Against this backdrop, and considering that the monthly CPI figure is still above the official forecast for this year, we suspect that the Copom will hold rates next week with a similarly narrow vote split to May.

In its last meeting, Copom voted 5-4 in favour of a slower pace of easing, with the four dissenting members appointed by the current government. A repeat in June should highlight the growing risks of the BCB coming into conflict once again with the pro-growth Lula administration, which could negate the positive impact on BRL from the more hawkish outcome. That said, risks ahead of the next meeting are again balanced, as they were in May.

On the one hand, a further cut of 25 basis points in June, bringing the Selic rate to 10.25%, would be a move consistent with both the Bank’s communiqués and the current balance of risks. On the other hand, a decision to keep the policy rate at the current 10.50%, as currently discounted by the markets, will be an important signal of the Bank’s reaction function to inflation risks and its ultimate intent to remain independent of political influence.



Simon Harvey, Head of FX Analysis


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