Has Inflation begun to give worrying signs?
When looking at the 12-month IPCA rate and its core by trimmed means with smoothing (Graph 1), there are no signs of impending inflation risk. But this is not what is indicated when considering the recent rise of food prices. The pandemic has triggered two important changes in the behavior of prices. First, it has changed the “consumption basket” of households, with increased weight of foods consumed at home and less weight of services. Second, the growing fiscal risk has caused a strong depreciation of the real – more than 30% since the start of January this year – and the pass-through of this depreciation to the wholesale prices of agricultural products and to the “food at home” component of the IPCA has been very strong and rapid. This is causing a change of relative prices. The prices of foods have been growing in relation to the prices of services, but the Central Bank will only react to this change if it has secondary effects, i.e., provokes an increase of inflation expectations. Since so far, the expectations are anchored to the target, for the time being there are no reasons to expect a reaction from the Central Bank. But will the present foreign exchange shock be transitory? The response rests with fiscal policy. The exchange rate has been weakening due to the fiscal risk, and if the government has the sanity to return to the spending cap, the pressures on the real will attenuate, with the same happening regarding inflation. However, if the current fiscal anchor is abandoned without finding any substitute, further weakening of the exchange rate will be in order, which will contaminate the expectations and raise even more the already steep slope of the yield curve due to the expectation of an increase of the SELIC rate.
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