Brazil: Inflation Continues to Strengthen Despite Weak Activity

Consensus Forecasts

Despite record-low interest rates and repeated government efforts to stimulate growth over the past year, the economy has yet to show clear signs of a recovery. More worryingly, stagnant growth has been accompanied by rising inflationary pressures in recent months. In particular, the inflation figure for March broke through the upper limit of the central bank’s mid-point target of 4.5% (+/-2.0%) for the first time since November 2011. After coming in at 6.31% (y-o-y) in February, consumer price increases accelerated further to 6.59% last month on the back of rising costs for food and other consumer items. Mounting inflationary pressures are a clear indication the central bank’s monetary easing cycle, which kicked-started in August 2011, has now come to an end. Indeed, just after our survey date, Banco Central do Brazil raised the benchmark SELIC rate by 25 basis points to 7.5%. The need to fight inflation has also been underscored by an unexpected drop in retail activity in February as rising prices are eroding consumer demand. In m-o-m terms, retail sales fell by 0.4%, and reported an annual contraction of 0.2%, the first year-on-year decline in almost a decade. Consumer spending was one of the remaining engines of growth in an otherwise sluggish economy. Tight labour market conditions and low borrowing costs have helped to bolster consumption even as investment and industrial output remained in the doldrums for much of the past year. Although this month’s interest rate hike spells the end of loose monetary conditions, many believe the tightening cycle will be moderate and gradual, especially with the economy continuing to show signs of softness. After a strong start to the year in which industrial output rose by 2.6% (m-o-m) in January, this was almost completely reversed by a 2.5% decline in February. In year-on-year terms, the sector contracted by 3.2%, with a drop in automobile output a key contributor behind industry’s weak performance.

Real GDP growth expectations for 2013 have remained firm, but the deteriorating outlook has been underscored by weaker forecasts for investment and industrial production. Furthermore, accelerating price pressures are reflected in an upgrade to end-year inflation forecasts.

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