Growth rates and interest rates not fully aligned in Brazil? An issue for Brazil’s leadership:
Inflation in Brazil
Behind the curve
The Central Bank acts belatedly to bring prices back under control
A CENTRAL bank knows it has lost control of inflation expectations when price rises become the subject of running gags. In Brazil the jokes feature tomatoes, which have suddenly become very pricey following floods, droughts and a big increase in freight costs. Social-media sites buzz with cartoons of bank robbers making off with crates of tomatoes and lottery winners bathing in purée. Even organised crime is diversifying into fruit: customs officers say that Paraguayan smugglers have added Argentine tomatoes to their Brazil-bound trade in drugs, cigarettes and knock-off electronics.
Official figures published on April 10th show that Brazil’s inflation problem goes well beyond salad. Prices rose by 6.6% during the past year, breaching the two-point tolerance band around the Central Bank’s 4.5% target. The price of more than two-thirds of the items used to calculate inflation rose in the past month. Now the mockery seems to have spurred the bank to act. On April 17th it raised the base interest-rate by 0.25 points, to 7.5%. Market watchers expect rates to hit 8.5% by the year’s end.
The belated rise comes just as it has sunk in that Brazil’s economy is failing to regain momentum after stalling last year. Fewer new jobs are being created. Industrial production and an economic-activity index widely seen as a leading indicator of GDP growth both fell in February after rising in January. Core retail sales fell for the first time in almost a decade, a particularly worrying sign given that only domestic consumption kept Brazil out of recession in 2012.
One reason the Central Bank gave for holding rates steady for so long was that inflation was being stoked by transient pressures such as a weaker currency and spiking food prices. Once those fed through, price rises would naturally moderate, it argued. The bank may also have been waiting to see if cuts in sales taxes on electricity, food, white goods and cars would hold back inflation, as the finance ministry argued they would.
More orthodox economists now feel vindicated in their predictions that automatic inflation-matching adjustments to wages, rents, professional fees and much else (a legacy of the country’s hyperinflationary past) would see price shocks ripple through the wider economy. As for the tax cuts, they seem to have fanned demand, buoying prices.
The belated interest-rate rise suggests that the bank recognises it needs to regain some lost credibility. Its operational independence has been in question since August 2011, when it cut rates even though inflation had reached 7.1%—and kept cutting even though inflation remained above target (see chart). Dilma Rousseff, the president, has trumpeted low interest rates as a “conquest” by her government ever since. Days before the bank’s monetary-policy meeting Guido Mantega, the finance minister, said that tackling inflation no longer required heavy artillery, as in the past.
Many analysts have concluded that the government was pressing the bank to keep rates low, with an eye to supporting Brazil’s weak economy. Nomura Securities, a broker, identifies a shift in mid-2011 in the relation between inflation expectations and subsequent interest-rate moves. The bank’s actions since then seem geared towards a tacit target-rate of somewhere between 5.5% and 6.5%, rather than the official 4.5% target, Nomura says.
As the tomato jokes suggest, Brazilians are still alert to inflation. A government that fails to keep it at bay can expect short shrift at the ballot box, especially from the poor, who are particularly sensitive to rising prices. A sub-index showing that inflation as experienced by those on modest wages is running well above general inflation will worry the government. Monetary policy generally takes six to nine months to take effect. If the government decides it would be best to get the pain over with before campaigning starts for elections in 2014, any future pressure it puts on the Central Bank may be upward.