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Headline inflation in Brazil came in slightly higher than economists expected at the beginning of the year. All-items IPCA fell only 0.11 percentage points from 4.62% in December to 4.51% year-on-year in January, undershooting expectations for a drop to 4.42%. This comes as inflation increased more than expected last month at a pace of 0.42%, although it is noteworthy that the monthly pace slowed from December’s rate of 0.56%.
Consequently, and despite the fact that the year-on-year reading has marked the fourth consecutive decline since the mini-inflation peak in September, we continue to maintain that positive base effects explain much of this phenomenon, as confirmed by the still high monthly inflation advance. In conjunction with unfavourable core and core services readings, the latest inflation data is further evidence that the BCB’s current pace of easing is likely to be called into question in the upcoming months.
Under our base case that the headline rate of inflation is set to decline more slowly than many think, we expect the current pace of easing (50bps increments) to decelerate during the second half of the year. We believe this was reflected in the slightly more hawkish rate statement last week, as the BCB’s choice of words and guidance suggested that the pace of rate cuts will be maintained after yesterday’s meeting probably for the first half of the year but with risks skewed to the upside towards the end of the year.
According to the note accompanying the data, seven of the nine categories recorded increases in January, with Transport, falling by 0.65% from the previous month, and Communications, which only marginally declined in January by 0.08%, the only exceptions. Once again, the Food and Beverages saw significant price growth, with an increase of 1.38%, its largest increase since July 2022. This meant that food prices were the largest contributor to overall inflation for the third successive month. According to the report, this increase has been the result of the rise in the price of some basic raw materials, especially carrots (+43.85%), potatoes (+29.45%) and mangoes (+23.35%), which reached their highest monthly levels since March 2022. Additionally, core inflation in services continued to make a large positive contribution in the reference period. Personal expenditure (0.82%) and health and personal care (0.83%) continued to contribute to the rise in inflation, behind only the food category.
Although the report does not include an estimate of the evolution of the underlying services component, we believe that it continues to move at an uncomfortably high level for the BCB seeing as the weak level of overall services inflation (0.02%) was largely driven by volatile components such as airfares.
Although the year-on-year reading for headline inflation slowed again in January, the three-month annualised rate has continued to strengthen since September
Overall, the upward trend in underlying core inflation casts doubt over the hypothesis that the mini inflationary peak that started after the summer months has passed. Although we may not see a repeat of the 2023 spike in headline inflation, we believe that the uncomfortably high level of core inflation and food inflation poses a risk that overall disinflation stalls, hampering the BCB’s ability to loosen monetary policy. While we expect this to come into scope in H2, Copom has made it clear that for now there is not enough evidence to deviate from its current roadmap and more inflation reports are likely to be needed going forward to confirm this trend before the bank significantly changes its tone and guidance.
With FX markets focused on the short-term, however, the increased risks of higher Brazilian rates towards year-end is having little impact as BRL falls alongside regional peers. That said, should the inflation signals become increasingly more concerning over the upcoming months, we expect FX markets to sit up and take notice, with the real likely to outperform peers as its easing cycle slows.
Author:
María Marcos, FX Market Analyst