High Brazil services inflation is hinting at even higher interest rates

May 11, 2015

Brazil's Finance Minister Joaquim Levy delivers a speech during a meeting with businessmen of the France-Brazil Chamber of Commerce in Sao Paulo

Brazil’s monthly inflation rate eased below 1 percent for the first time this year in April and inflation expectations for 2016 have dropped for the first time in two and a half months.

That should be welcome news for an economy heading into recession but which is caught in a strangehold of relentlessly rising prices going completely against a global trend.

And yet economists — who if anything haven’t been aggressive enough in the recent past — are still forecasting higher rates from Brazil’s central bank.

Brazil’s main interest rate is already at 13.25 percent, dwarfing other similar Latin American neighbors and the central bank is completely out of step other key emerging economies. (India has cut rates twice this year and China just cut its lending rate to 5.1 percent on the weekend.)

Why? Services inflation remains worryingly high. It is running above 8 percent a year, so far shrugging off mounting job losses and rising interest rates. Brazil’s main inflation rate is 8.2 percent. (China’s has just tumbled to 1.5 percent.)

What is remarkable is how services inflation can remain so high in Brazil even though its economy looks headed into a painful recession.

Most services, such as housekeeping and repairing, are directly affected by pay growth, which has slowed sharply in recent months as the job market cools.

Yet even stripping out airfares, which stand out from other services for volatile prices linked to fuel costs and the exchange rate, services inflation accelerated slightly to 8.6 percent in the 12 months through April, from 8.5 percent in March, according to a research note from economists at Brasil Plural.

That might suggest that there is still not enough slack in the job market.

But there’s another more dangerous explanation. Inflation may be high today because it has been that way for a very long time, and so that’s what people expect.

“Given Brazil’s history of hyperinflation and indexation, inflation inertia has become the biggest threat to the central bank’s goal of bringing inflation back to target center next year,” said Luciano Rostagno, chief strategist at Banco Mizuho do Brasil, in Sao Paulo.

Services inflation has been running above 8 percent for 30 months now, according to Goldman Sachs research.

For the central bank to achieve its target of cutting inflation nearly by half from 8 percent to the 4.5 percent target by next year, analysts say it will need to overlook the first signs of respite and stay serious in controlling expectations.

That will be increasingly painful for Brazilian workers and voters.

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