Depec-Bradesco Economic Highlights - Economia em Dia

Macroeconomic Research Department
Depec-Bradesco Economic
Highlights
Year IX Number 8 - February, 25 2011
The decision to raise interest rates by 50 bps at next week’s Copom
meeting is undoubtedly the right call in light of the deceleration in
economic activity that is already underway
The 50 bps interest rate hike that the Copom is likely
to implement next week is part of a coordinated
economic policy action – which includes a marked
reduction in the growth of public spending as well
as macro-prudential measures – in order to bring
infl ation to the center of the target over the course of
2012. In our view, this economic policy strategy, the
deceleration that is already underway in economic
activity and the fact that part of the deterioration
in infl ation and in infl ation expectations is due to
commodity shocks – to be accommodated in the
infl ation band – are more than enough to justify an
increase of at most 50 bps at this meeting, followed
by the possibility of another 50 bps hike at April’s
meeting, if necessary.
The motive for an additional hike in interest rates
and for a coordinated economic policy action
lays in the recent deterioration in the consumer
infl ation indices. However, the infl ationary shock
during this fi rst quarter, which should come out to
a fi gure of 2.25% instead of the 1.87% expected
by the Central Bank in its last infl ation report, is
the result, in our opinion, of the lagged effects
of the upturn in economic activity, particularly
in the labor market, and of the recent shock in
Aug/02 = 100
580,0
480,0
380,0
280,0
180,0
80,0
15/11/2002
126,7
07/03/2003
Agricultural index
Industrial index
Energy index
27/06/2003
17/10/2003
171,4
06/02/2004
28/05/2004
104,9
17/09/2004
07/01/2005
29/04/2005
243,7
352,3
Also from the point of view of infl ation, part of
the deterioration in the infl ation expectations
for this year is due precisely to this primary
19/08/2005
09/12/2005
31/03/2006
21/07/2006
10/11/2006
02/03/2007
22/06/2007
12/10/2007
01/02/2008
23/05/2008
DEPEC team
commodity prices. We do not believe that the
infl ation expectations bring any new, exogenous
information that can explain the deterioration in
the infl ationary picture.
Starting off the argument with the effects of the
commodities shock in headline inflation, in an
infl ation target mechanism it makes no sense for the
Central Bank to tackle the entire primary price shock
(increase in international commodity prices) within
a short timeframe, making excessive sacrifi ces in
terms of economic growth. It is precisely for this
reason that there are bands around the central
inflation target, so that potential unanticipated
shocks are absorbed over a certain period of time.
In this context, an important part of the “error” in
terms of the forecast for the fi rst quarter is linked to
the intensity of this commodities shock, as can be
noted in the following graph. Therefore, it seems
reasonable to assume that the Central Bank will
not exaggerate the increase in interest rates to the
point where infl ation converges with the center of
the target before the end of 2011, bearing in mind
that this would demand an enormous contraction in
Brazil’s GDP and would certainly lead to a belowtarget
level of infl ation in 2012.
541,3
406,0
285,3
12/09/2008
138,9
02/01/2009
24/04/2009
14/08/2009
04/12/2009
356,9
26/03/2010
213,2
16/07/2010
05/11/2010
25/02/2011
402,2
384,8
382,3
Commodity prices
Index
Source: Bloomberg
Produced by: BRADESCO
commodities shock – which the Central Bank
should also analyze with a degree of caution when
considering the effect of infl ation expectations on
1

Depec-Bradeso Economic Highlights
the projected infl ation in their model. Hypothetically,
let’s imagine a situation where infl ation is in the center
of the target at the start of a year and that, solely
on account of an external shock, both infl ation and
infl ation expectations point to a higher-than-target
value. In this case, it makes no sense to assume
that there are two vectors pushing infl ation up: one
from the external shock which leads to an increase
in current infl ation and another from an “exogenous”
deterioration in expectations. Expectations have
worsened fundamentally because of the shock and
not on account of any other factor. Therefore, to say
8,5%
6,5%
4,5%
2,5%
5,2%
7,2%
8,1%
5,5%
4,4%
3,0%
mar/04
mai/04
jul/04
set/04
nov/04
jan/05
mar/05
mai/05
jul/05
set/05
nov/05
jan/06
mar/06
mai/06
jul/06
set/06
nov/06
jan/07
mar/07
mai/07
jul/07
set/07
nov/07
jan/08
mar/08
mai/08
jul/08
set/08
nov/08
jan/09
mar/09
mai/09
jul/09
set/09
nov/09
jan/10
mar/10
mai/10
jul/10
set/10
nov/10
jan/11
With regard to the infl ation cores, our diagnosis is that
the acceleration seen over the last few months is the
lagged refl ex of last year’s growth in economic activity,
particularly in the labor market. It’s like taking a look in
the rear-view mirror: the infl ation that we are experiencing
right now is the result of the marked level of economic
activity that was registered in previous quarters. As
5,6%
5,1%
that the deterioration in infl ation expectations would
be an additional risk factor is wrong, and is the same
as counting the same shock twice. As a result, in our
opinion, the deterioration in the infl ation expectations
for 2011 is suffering to a marked degree from this
“double counting” effect due to the pronounced
correlation between infl ation expectations and current
infl ation, infl uenced by the commodities shock. In
addition to this pronounced correlation with current
infl ation, as can be observed in the following graph,
the predictive power of infl ation expectations at times
of external shocks seems even smaller.
6,4%
IPCA
Expectations 12 months forward
4,0%
5,3%
4,5%
5,9%
5,5%
IPCA infl ation
and infl ation
expectations 12
months ahead,
synchronized 2004
- 2011
Source: IBGE, BC
Produced by: BRADESCO
can be noted in the following table, among the main
determinants of the underlying infl ation, the items that
most draw attention are the earnings of households and
the labor market. What is expected regarding this aspect
is that the Central Bank will adjust its instruments in order
to bring economic growth to below potential, and in our
opinion, this is what is currently being done.
July 2008 February 2011
Expectation for the current year 6.50% 5.79%
Change in 6 months (bps) 213 88
Expectation for the next year 4.98% 4.78%
Change in 6 months (bps) 94 28
Infl ation for the previous year 4.46% 5.91%
Gap (6 month average) 2.14% 0.52%
Commodities in reais (variation over 6 months) 17.68% 16.29%
Unemployment Rate (6 month average) 7.93% 6.46%
Real Earnings (annualized 6 month variation) 4.42% 8.19%
Domestic Absorption (annualized 2 quarters variation) 9.93% 7.35%
Even before the start of the monetary tightening cycle
that is currently in progress, economic activity had
already been giving signs that growth, in the margin, is
below potential and the fi gures for the labor market point
unmistakably in this direction, as can be observed in the
graphs below. Growth in engagement and in earnings
dropped from a fi gure close to 1.0% at the end of last
Comparison between
indicators which are
signifi cant for infl ation
during monetary tightening
cycles
2008 - 2011
Source: IBGE, BC
Produced by: BRADESCO
year to a slightly negative fi gure at the start of this
year, while engagement recently slowed down from a
monthly rate of slightly more than 1.0% to a fi gure of
less than 0.5%. Brazilian industrial production has been
showing stability since the second last quarter of last
year, retail sector sales are showing the fi rst signs of
deceleration and apparent consumption of machinery
DEPEC
2

Depec-Bradeso Economic Highlights
and equipment, which is a proxy for investments, has
been slowing down. The output gap as measured by
the IBC-Br index seems to be converging on stability
and, in a more comprehensive way, since the second
half of last year Brazilian GDP growth has certainly
been below potential 1 . Therefore, we see no reason for
1,8%
1,2%
0,6%
0,35%
0,0%
-0,04%
-0,6%
-1,2%
Growth in
engagement: growth
in the margin and in
the 3-month moving
average
4,9%
3,5%
2,1%
0,91%
0,75%
0,7%
-0,7%
-2,1%
-2,09%
-3,5%
-4,9%
-6,3%
nominal
real
Neutral level
0,21%
0,78%
-0,96%
1,31%
-0,14%
1,35%
0,04%
-1,65%
0,66%
1,10%
-0,42%
1,55%
1,39%
-0,54%
1,59%
-0,84%
0,69%
0,30%
3,95%
3,00%
-4,79%
excessively speeding up or extending the interest rate
cycle at the very moment in which economic activity is
already showing signs of slowing down, which will be
reinforced by the effects of the fi scal measures aimed at
reducing the rate of growth in spending and the macroprudential
measures that are underway.
1,98%
out/03
dez/03
fev/04
abr/04
jun/04
ago/04
out/04
dez/04
fev/05
abr/05
jun/05
ago/05
out/05
dez/05
fev/06
abr/06
jun/06
ago/06
out/06
dez/06
fev/07
abr/07
jun/07
ago/07
out/07
dez/07
fev/08
abr/08
jun/08
ago/08
out/08
dez/08
fev/09
abr/09
jun/09
ago/09
out/09
dez/09
fev/10
abr/10
jun/10
ago/10
out/10
dez/10
-0,08%
-0,59%
3-month interpolated
average variation
(seasonally
adjusted) of nominal
and real earnings
Output gap calculated
based on the IBC-Br
(using an HP fi lter)
1 Brazilian GDP has been growing at an annualized rate of less than 3% since the third quarter of 2010 if we take into account our projections for the
current quarter and the previous quarter.
-0,16%
1,31%
0,35%
1,50%
1,10%
jan/07
fev/07
mar/07
abr/07
mai/07
jun/07
jul/07
ago/07
set/07
out/07
nov/07
dez/07
jan/08
fev/08
mar/08
abr/08
mai/08
jun/08
jul/08
ago/08
set/08
out/08
nov/08
dez/08
jan/09
fev/09
mar/09
abr/09
mai/09
jun/09
jul/09
ago/09
set/09
out/09
nov/09
dez/09
jan/10
fev/10
mar/10
abr/10
mai/10
jun/10
jul/10
ago/10
set/10
out/10
nov/10
dez/10
jan/11
fev/11
Source: IBGE
Produced by: BRADESCO
2,0%
1,5%
1,0% 0,89%
0,5%
0,0%
-0,5%
-1,0%
0,14%
0,65%
0,58%
0,35%
0,05%
-0,23%
0,87%
0,17%
0,02%
-0,64%
Monthly variation
3 month moving average
0,07%
-0,05%
-0,20%
-0,36%
0,12% 0,22%
0,92%
0,28%
0,00%
-0,11%
0,22%
-0,39%
0,92%
0,81%
0,53%
0,43%
0,23%
0,08%
Source: IBGE
Produced by: BRADESCO
-0,57%
0,69%
-0,10%
0,33%
0,23%
jan/08
fev/08
mar/08
abr/08
mai/08
jun/08
jul/08
ago/08
set/08
out/08
nov/08
dez/08
jan/09
fev/09
mar/09
abr/09
mai/09
jun/09
jul/09
ago/09
set/09
out/09
nov/09
dez/09
jan/10
fev/10
mar/10
abr/10
mai/10
jun/10
jul/10
ago/10
set/10
out/10
nov/10
dez/10
jan/11
Source: Bacen
Produced by: BRADESCO
DEPEC
0,03%
-0,15%
0,34%
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Depec-Bradeso Economic Highlights
If the pace of economic activity over the next few months
is still incompatible with the convergence of the infl ation
cores onto the center of the target, another signifi cant
question that the Central Bank will have to deal with will
relate to the instruments to be utilized in order to bring
about convergence. An important part of the diagnosis
of the current deceleration of economic activity is due
to the interpretation that the increase in imports and the
“weakness” of exports of manufactured goods is acting
like a brake upon GDP growth, channeling overseas
the excess domestic demand 2 . This diagnosis, coupled
with the unusual circumstances in the manner which
monetary policy is being implemented in the world mean
that the traditional usage of interest rates by the Central
Bank may be less intense in the present monetary
tightening cycle, in case a greater-than-presentlyexpected
increase is required. This is because of the
fact that the increase in interest rates has an impact
on the FX rate, making it appreciate even more during
a time of excess global liquidity.
8,0%
6,9%
7,0%
6,0% 5,8%
5,0%
4,0%
3,0%
2,0%
1,0%
0,0%
-1,0%
-2,0%
4,1% 3,8%
3,4%
2,3% 2,0% 1,8%1,6% 1,5% 1,4% 1,3% 1,2%
1,0% 1,0%
If the Brazilian Central Bank is one of the only ones to
excessively raise interest rates in this global context in
which the interest rates of the developed countries are
extremely low – and operating by means of quantitative
mechanisms – and the emerging economies are making
greater use of macro-prudential measures than of
interest rates, then Brazil’s FX could perhaps register
an excessive appreciation. Such an appreciation in
the real would aggravate the economy’s external
competitiveness 3 . The signs given off by the present
administration suggest that this is an important theme
for the economic policymakers and, therefore, the side
effects of raising interest rates cannot be overlooked
in this economic policy framework. As a result, any
aggressive action in terms of raising interest rates in this
phase, in addition to not being justifi ed on account of the
slowing down in economic activity, does not seem very
likely in our opinion, as it would aggravate the external
leak and intensify the deceleration in economic activity
that is already underway.
0,4% 0,2% 0,2% 0,2%
Venezuela
Serbia
Romania
Estonia
Greece
Uruguay
Indonesia
U K
Portugal
Thailand
Singapore
Malta
Brazil
Spain
Belgium
Colombia
Slovakia
Poland
India
Korea
Luxemburg
Hungary
Finland
China
Austria
Mexico
South Africa
Euro Zone
Canada
Italy
Slovenia
France
Holland
Germany
Australia
Cyprus
Sweden
Ireland
Czech Republic
USA
Peru
Philippines
Chile
Therefore, in our opinion, the Copom will raise interest
rates by 50 bps at this meeting and will wait to see the
results of this monetary policy action combined with
the macro-prudential, fi scal and para-fi scal measures.
In addition to being effective, it seems to us that these
actions will be come on top of a deceleration that is
already underway in the factor that has been the main
vector of infl ationary acceleration over the last few
months, namely the labor market. As a result of this,
in our opinion there is no justifi cation for any more
-0,3%
-1,0%
Comparison
between the
12-month infl ation
differential
(headline) and each
country’s infl ation
target
Source: CEIC
Produced by: BRADESCO
pronounced acceleration in the intensity or total size
of the interest rate cycle, at the very moment in which
the vectors that govern infl ation are pointing to a much
more favorable outlook for the cores.
Summing up, we are not underestimating the infl ationary
phenomenon and we recognize that inflation is a
challenge that faces Brazil as well as dozens of other
countries. However, the already clear endogenous
or induced signs of deceleration lead us to believe
2 Nor can we fail to take into account that part of the deceleration that is already being seen in the economy may be the result of the increase in interest
rates that the Central Bank implemented during the fi rst half of last year, the empirical results of which were expected to be seen at the end of that year.
Although the transmission channels of that interest rate increase are not clear – after all, interest rates on credit continued to drop, the level of confi dence
of businessmen and consumers was not affected – it is possible that the appreciation in the real FX rate that followed and households’ consumption and
savings decisions have meant that the increase in interest rates was transmitted to economic activity. Incidentally, the interest rate that matters to the
economy is the real swap rate and this has been increasing since the middle of 2009 by roughly 2.0 p.p. during the period, which leads us to believe that,
in effect, part of the economic activity adjustment may have come through this channel.
3 This appreciation would certainly help to reduce infl ation, and the increase in interest rates would eventually lead to a decrease in the country’s external
defi cit at a later time, on account of the moderating effect on domestic demand. However, initially the effect would be to aggravate the loss of competitiveness.
DEPEC
4

Depec-Bradeso Economic Highlights
that this is not the moment to step up the pace of
monetary tightening. In addition to this, depending upon
developments in relation to the crisis in North African
and Middle Eastern countries, we have to consider
Team
Octavio de Barros - Macroeconomic Research Director
Marcelo Cirne de Toledo / Fernando Honorato Barbosa
the possibility of an impact on the level of economic
activity in the developed countries, which may be
signifi cant and which could have obvious infl ationary
consequences.
Global economics: Fabiana D’Atri / Daniel Valladares Weeks / Daniela Cunha de Lima /Igor Velecico / Thomas Henrique Schreurs Pires /
Matheus Ribeiro Machado
Brazil: Robson Rodrigues Pereira / Andréa Bastos Damico / Ana Paula Almeida / Ellen Regina Steter / Myriã Bast / Renata Rodovalho Gonçalves
Brazilian sectors: Regina Helena Couto Silva / Priscila Pacheco Trigo / Rita de Cassia Milani
Proprietary survey: Fernando Freitas / Ana Maria Bonomi Barufi / Leandro Câmara Negrão
Internships: Laura Pinto Gonçalves / Felipe Cardoso D´Avila / Mirella P. Amaro Hirakawa / Wellington Barbosa Nunes / Daiane Cristina Montanari
DEPEC - BRADESCO does not accept responsibility for any actions/decisions that may be taken based on the information provided in its publications and projections. All the
data and opinions contained in these information bulletins is carefully checked and drawn up by fully qualifi ed professionals, but it should not be used, under any hypothesis, as
the basis, support, guidance or norm for any document, valuations, judgments or decision taking, whether of a formal or informal nature. Therefore, we emphasize that all the
consequences and responsibility for using any data or analysis contained in this publication is assumed exclusively by the user, exempting BRADESCO from all responsibility
for any actions resulting from the usage of this material. We all point out that access to this information implies acceptance in full of this term of responsibility and usage.
DEPEC
5