Brazil: Inflation Report Points to a Scenario Too Good for the BCB Board to Believe it

The Brazilian Central Bank has released its Quarterly Inflation Report for the first quarter of 2024. Overall, the report reflects the position of the BCB board from their last meeting. In many factors, some mixed messages were sent, reflecting greatly on the uncertainty of the board regarding the prospective disinflationary process and the need for caution in the conduct of monetary policy.

Inflation

Regarding inflation, the report stated that the BCB expects disinflation to occur more slowly this year. It was also highlighted that in the last months, inflation surprised to the upside due to inflationary pressures on services and food and beverages. However, the BCB's forecasts indicate that inflation will finish 2024 at 3.5%, very close to the BCB target, which suggests a certain level of optimism, as the market expects a 3.8% rise. Additionally, a decomposition exercise of the deviation of inflation in relation to the target was presented, highlighting the importance of imported inflation (highly influenced by the exchange rate) in 2023 to lower inflation last year.

Labour Market

Although the labor market has shown signs of being hot, the BCB's communiqué does not appear to be greatly concerned about its evolution and follows the basis of the last communiqué, observing if there will be any inflationary pressure coming from the labor market. Looking at formal employment jobs with data coming from administrative sources, job creation has been decelerating, and although real wages (in the formal sector) have grown above inflation, their level is more or less approaching 2018 levels. Looking at household surveys, the story is a bit different, as data shows occupation growing above the labor force and real wages accelerating well above inflation, reaching the highest point in the time series. The mismatch between both sets of data justifies the BCB's skepticism about the impact of the labor market on inflation.

Credit

In terms of credit evolution, despite the BCB lowering rates, the degree of monetary policy tightening is set to continue decelerating credit growth in 2024. Data has shown that in 2023, credit growth decelerated from a 16% nominal rate to 8%. Additionally, the new credit measures announced by the government are likely to have a marginal effect on overall credit concessions during this year. Additionally, delinquency rates have increased, indicating that tight monetary policy is taking its toll on credit.

Output Gap

Regarding the output gap, the BCB revealed its in-house output gap estimation. Interestingly, the output gap continues to be negative. This contrasts with the estimation of FGV (a private research institute), which suggests the output gap was positive in the last quarter of 2023. Although the BCB highlighted the uncertainty over this measure, the BB indicates that they are working with a scenario in which the output gap is not exerting pressure on inflation. Therefore, the BCB's job is mostly related to dissipating inertial inflationary pressure and aligning expectations.

The Conduct of Monetary Policy

Overall, the inflation report points to a more benevolent scenario than that pointed out by their minutes and communiqués. However, unaligned expectations and the fiscal situation are likely preventing the BCB from making stronger cuts. The recent inflationary surprises contrast with a scenario of a negative output gap and credit deceleration. It remains to be seen whether they will indeed decelerate the pace of cuts from the current 50bps to 25bps in June, but for the moment, we maintain our view that this will be the case.