Column: Is Brazil heading for monetary overkill?
ORLANDO, Fla. (Reuters) – Brazil’s central bank has placed itself at the forefront of the global battle against inflation, but its aggressive monetary tightening threatens to stifle the economy.
With annual inflation of 10%, the central bank will fail to meet its central target of 3.75% this year and possibly also the target of 3.50% next year. A chronically weak currency and renewed concerns about public finances only redouble its commitment to raise rates.
In many ways, he has little choice.
Unlike the US Fed or the European Central Bank which recently blurred their inflation targeting guidelines to give themselves greater political flexibility, the Brazilian central bank’s framework is more rigid.
He has an end-of-year target, with a margin of error of 1.5 percentage points on either side, which leaves some room for maneuver. But it is indeed indebted to a one-time forecast, and given Brazil’s hyper-inflationary past, policymakers are loath to risk their credibility by failing it.
That’s why the bank’s rate-setting committee, known as “Copom”, will deliver its fifth straight rate hike on September 22. The only question is whether the Selic benchmark rate will be raised by 100 basis points, as in August, or Continued.
But it is a blunt tool, and the economic outlook is darkening.
By some measures, real interest rates are not deeply negative, as the current hypothesis claims, but are in fact among the highest of all major economies.
Robin Brooks of the International Institute of Finance in Washington calculates that, based on nominal 10-year government bond yields and 10-year break-even inflation rates, Brazil’s real interest rate is slightly lower at 5 %.
It is the highest among a range of key developed and emerging economies.
Brooks says the use of longer-term inflation measures eliminates current supply bottleneck issues and “noise” in recent inflation readings, giving a more accurate picture.
Jason Vieira at Infinity Asset Management in Sao Paulo uses a shorter-term perspective, but comes to a similar conclusion. Based on the difference between the most liquid 12-month interest rate futures and projected inflation over the next year, he calculates that real rates in Brazil are around 2.5%. .
It may not seem like much, but according to his analysis of 40 major developed and emerging economies, it is the second highest country in the world behind Turkey. And he sees it go above 4% next year.
The recent fluctuations in inflation, currency and interest rates in Brazil have been remarkable.
The Copom now commands one of the most aggressive rate hike cycles of any G20 central bank, and inflation is the third highest of any G20 country behind Argentina and Turkey.
Yet in May of last year, inflation was the lowest in Brazilian history, below 2%, and as recently as March of this year, the Selic was at its lowest level of. 2.00%. Selic’s current rate is 5.25% and his terminal rate could be closer to 10%.
Former central bank chief Arminio Fraga shares the orthodox view that the central bank has no choice but to raise rates in order to bolster its credibility on inflation, to support the currency and counter the deteriorating fiscal outlook.
“We are not yet in a situation fully under control,” he told Reuters earlier this month.
But he also acknowledged that growth has long been “really poor”. Periods of growth are generally “low and very volatile,” and extend beyond the pandemic and short-term business cycles.
According to the central bank’s latest weekly “FOCUS” survey of more than 100 economists, Brazil is set to grow by 5% this year. This is a solid “V” recovery from last year’s contraction of 4.1%, as Economy Minister Paulo Guedes often points out.
Still, the median “FOCUS” forecast for next year fell to 1.6% GDP growth from 2% three weeks ago. In March, it was 2.5%.
Brazil’s economy is more than half a decade lost. It’s 3% below its peak in early 2014, and since then it has suffered two deep recessions and hasn’t grown more than 2% in 2017, 2018 or 2019.
Unemployment has remained chronically high. It’s been above 14% for most of last year, and the last time it was below 10% was almost six years ago.
The underlying figures also show that if the labor market participation rate were at pre-crisis levels, unemployment would exceed 20%. More than 30 million people, or almost a third of the working population, are underemployed.
Significantly higher interest rates are unlikely to reduce or strengthen Brazil’s short-term growth momentum.
The views expressed here are those of the author, columnist for Reuters.
By Jamie McGeever in Orlando, Florida; Editing by Matthew Lewis