Monetary Policy: Smooth sailing ahead

BRAZIL ECONOMICS - Report 15 Apr 2019 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

Despite the general acknowledgment that the recent inflation elevation is all due to passing shocks, the question has arisen: Will these shocks be incorporated into inflation expectations? Shocks that are absorbed into expectations become inflation expressions, but for this outcome the economic recovery would have to be accelerating, along with decrease of (negative) GDP gap, neither of which is happening. The surprise in March can be attributed to forces exogenous to economic activity, which is still recovering very lethargically. After the end of the shocks, inflation will remain low, prompting rising pressures to cut the interest rate. We reiterate that this action will only be reasonable if: a) the Central Bank is aided by approval of a robust pension reform; and b) the slow recovery leads to an inflation projection below the target in 2020.

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