ANALYSIS-Stagflation-lite looms for Brazil

BRASILIA, April 15 (Reuters) – Brazil is slipping towards ‘stagflation’ as it teeters on the brink of recession and inflation surges above the official year-end target, putting the central bank into an increasingly difficult position.

How should it nip price pressures in the bud without causing further damage to an economy ravaged by one of the world’s deadliest COVID-19 epidemics?

“In part, this is happening in Brazil because higher production costs are putting pressure on inflation, and hurting economic activity,” said Caio Megale, chief economist at XP Investimentos and a former Economy Ministry official.

Like many, Megale believes the central bank will keep inflation under control and that any bout of stagflation will be relatively mild.

But he recognizes the potential for high inflation now to fuel future expectations, especially in an economy with a history of high inflation where index-linked contracts and agreements still have prominence.

The central bank raised its benchmark Selic interest rate last month for the first time in six years, to 2.75% from a record low 2.00%.

With annual inflation now 6.1%, well above the bank’s 3.75% year-end goal, central bank chief Roberto Campos Neto has said hiking will be front-loaded to keep expectations for 2022 and beyond in check, and to avoid steep rises.

Many economists reckon inflation will top 7% soon. Brazil’s real currency has fallen almost 10% this year following last year’s 25% slump, while IHS Markit’s purchasing managers index data show input costs across manufacturing and services are the highest since the data series began in 2007.

The fiscal outlook, with President Jair Bolsonaro still to sign the 2021 budget and the government potentially on track to break its “spending ceiling” rule this year, is also stoking inflation fears.


“Brazil appears particularly vulnerable to a larger and more persistent increase in inflation … given unsettled domestic economic, policy, and political dynamics,” economists at Goldman Sachs wrote in a note, citing the exchange rate, the degree of anchoring of inflation expectations, and near-term policy.

Even though the central bank is raising borrowing costs, the real Selic rate is minus 3.35%, the lowest in over 20 years.

Campos Neto has repeatedly defended the bank’s ‘partial normalization’ stance. “We need to move rates but still be on stimulative ground,” he said on Tuesday.

That is largely because the near-term growth outlook is deteriorating, as the pandemic shows no sign of abating, and fiscal and political logjams in Brasilia sour business, consumer and investor sentiment.

Unemployment, meanwhile, has risen above 14% and could soon top its 2020 – and all-time data series – high of 14.6%.

These dynamics are likely to persist in the next few months before mass vaccinations help the economy rebound in the second half of the year. That might also be when the commodity price and exchange rate shocks start to fade too.

Economists at BNP Paribas this week forecast a technical recession, seeing the economy shrinking 0.7% in the first quarter and 1.3% in the second.

But, like many of his counterparts, Gustavo Arruda, the bank’s head of Latin American research, is confident Brazil’s stagflation will be mild and short-lived – a far cry from the self-perpetuating combination of energy price shock and wage rise spiral that blighted many major economies in the 1970s.

“Monetary policy will not run the risk of allowing inflation expectations to become unanchored,” Arruda said.

($1 = 5.70 reais)

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