The Signs of Economic Activity and Monetary Policy

BRAZIL ECONOMICS - Report 14 Feb 2024 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

For inflation to converge to the target, it is necessary for economic activity to decelerate sufficiently for inflation expectations to equal the target. Although after the strong result observed in November (mainly due to Black Friday promotions), real retail sales cooled, our models indicate that based on the data for the fourth quarter last year, GDP for 2023 as a whole expanded by slightly more than 3%, leaving a positive carry-over to 2024.

The payments of judicial credit warrants (precatórios), which have been available to the beneficiaries since the start of January, should boost activity at the beginning of the year. With the labor market still tight (unemployment rate below 8%) and consumption stimulated by the positive fiscal impulse, the risk of higher inflation has increased. In the minutes of the last COPOM meeting, the Central Bank expressed a clear warning about inflation of service prices. The strong fiscal impulse of 2023 kept the labor market hot, with the supply of workers being negatively affected by the decrease of the participation rate, in turn caused by more generous income transfers. The sum of these two factors is reflected in the upward movement of wages, stimulating demand for consumer goods and elevating the inflation of services.

For the time being, the Central Bank has maintained its forward guidance of 50-basis-point cuts in the SELIC rate at the next two COPOM meetings, but for the rate to end the easing cycle at the 9% forecast by the Focus survey, a substantial decrease of inflation expectations will be necessary, which we believe will be hampered by the strong unanchoring of expectations combined with the resilience of service cost inflation. There are two possible reactions: either the Central Bank can end the easing cycle with the SELIC rate above 9%, seeking to anchor expectations to the target; or it can end the cycle with the SELIC rate at the announced 9%, leaving expectations unanchored, as if the Bank is tolerant of expectations higher than the target.

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