Brazil’s relentless rate hikes shielding economy from inflation bout

June 16, 2015

Employee arranges pricetags at vegetables work bench during the opening day of upmarket Italian food hall chain Eataly's flagship store in downtown Milan

Brazil’s relentless series of interest rates hikes is successfully lowering inflation expectations – despite recent signs to the contrary, from lottery to tomato prices.

Brazil’s inflation has quickened since the beginning of the year mostly because of increases in government-regulated prices such as electricity rates and gasoline. The inflation rate jumped yet again in May, approaching 8.5 percent, boosted by a steep rise in prices of fresh vegetables such as tomatoes and onions, highly unusual for this time of the year.

The increase dampened hopes that the central bank could soon stop raising interest rates, as many economists at leading financial institutions and government officials had started to predict. At 13.75 percent, Brazilian interest rates are already the highest among the world’s 10 largest economies. Analysts expect them to continue rising in July and perhaps in September, topping 14 percent.

Brazil’s high rates have put the economy on the brink of its worst recession in 25 years. But sacrifice is paying off: according to a weekly central bank poll of economists, high rates have also kept inflation expectations under control. The chart below illustrates how forecasts for 2017 and 2018 inflation have fallen nearly 1 percentage point towards the center of the official target at 4.5 percent.

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Cristiano Oliveira, chief economist at Banco Fibra, in Sao Paulo, estimates real interest rates – currently at 7.65 percent – are already far above his highest estimate for neutral rates, ranging from 4.8 to 6.5 percent.

“Monetary policy is very contractionist already and its greatest impact should still become evident as it acts with a lag,” he wrote in a report.

The five most accurate forecasters in the bank’s poll are also more upbeat about Brazil’s inflation. Their median estimate for the inflation rate at end-2016 fell to 5.21 percent from 6.00 percent in one week.

The central bank’s own inflation forecasts may drop later this month as it releases its quarterly inflation report. If that happens, as many economists anticipate, the bank could signal it is ready to stop raising interest rates.

In the meantime, watch El NiƱo. The weather pattern, known for warming up Pacific waters and throwing the global climate into disarray, could help ease food inflation in Brazil later this year by improving rain conditions in key production areas, according to economists at Bradesco.

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