Inflation, Exchange Rate and Economic Activity

BRAZIL ECONOMICS - Report 20 Feb 2017 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

Inflation has been falling steeply, as well as the 12-month projections. The negative GDP gap is belatedly producing its effects. In light of this, the Central Bank will continue lowering the SELIC rate, which we project to reach 9.5% at the end of 2017, and this will not be the end of the easing cycle.

Might the recent rally of the real alter this picture? It comes partly from the gains in the terms of trade, but the main contribution comes from the improvement in the risk perception, which raises demand for Brazilian assets and reduces hedge positions. But for the Central Bank to react to this appreciation, increasing the monetary easing dose, this movement will have to be persistent, and the available information discussed in this Report does not allow any conclusive forecast in this respect. We also do not believe the likelihood is high of deterioration of the political scenario to the point of increasing the risk perception and weakening the exchange rate. Our prediction is hence that the reduction of the SELIC rate will continue as signaled by the Central Bank.

The recession is nearing its end, and the economy should grow slightly in 2017, more so in the second half. The interest rate cuts, some additional recovery of commodity prices, and emergency measures like release of funds from FGTS accounts will help recovery, but will not be enough to appreciably change the outlook for very modest growth.

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