Brazilian inflation ended 2017 somewhat below the lower limit of the tolerance band

Governor Goldfajn released an open letter to the Finance Minister explaining why inflation slightly breached the lower limit

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The IPCA climbed 0.44% in December, topping our call (0.32%) and the highest of market expectations (0.38%; median at 0.30%). Food and apparel were behind the biggest surprises compared to our forecast. The index ended the year up by 2.95%, slightly below the lower bound of the inflation tolerance range (3.0%). Headline inflation was 3.34 p.p. lower than the 6.29% increase registered in 2016. According to census bureau IBGE, it was the lowest annual reading since 1998. Market-set prices rose 0.52% in December, ending the year up by 1.3% (6.6% in 2016). Regulated prices advanced 0.21% during the month and 8.0% last year (5.5% in 2016). Among market-set prices, prices for food consumed at home advanced 0.42% in December but posted 4.9% deflation in 2017 (+9.4% in 2016); service prices increased 0.59% during the month and 4.5% during the year (6.5% in 2016); industrial prices climbed 0.46% in December and 1.0% in 2017 (4.8% in 2016). Our preliminary estimate for the IPCA in January is a 0.32% advance, keeping the year-over-year change at 2.9%. Food and transportation will provide the biggest upward contributions during the month. On the other hand, the housing group is expected to post a negative change for a second consecutive month, reflecting another drop in electricity bills due to the activation of the green mode in the tariff flag system early in the month. ** Full Story here.

As required by the inflation targeting regime in Brazil, the president of the central bank, Ilan Goldfajn, released an open letter to the Finance Minister, Henrique Meirelles, explaining why inflation in 2017 (2.95%) has slightly breached the lower limit of the tolerance band (3%). In said letter, Governor Goldfajn described in details the reasons for the infringement. Fairly enough, a great emphasis was placed on food inflation, which has dropped from 16.79% at its peak in August 2016 to -4.85% at the end of 2017 and has experienced the sharpest 12-month drop of the series starting in 1989. That exceptional behavior stemmed mostly from food supply shocks which, as repeatedly argued by the central bank, should only require a response by monetary policy if they produce secondary effects on other prices.

Governor Goldfajn also mentioned the drops in services prices and reckons that the disinflationary process, while intensified by food prices, has been widespread. But he cites that model-based calculations show that more than 80% of the deviation from the target can be accounted for by supply shocks. In describing the actions taken by the central bank to control inflation, Governor Goldfajn splits these in two moments. The first, starting in 2016, when inflationary expectations were unanchored and the Selic rate was kept at 14.25%, the level that was prevalent since July 2015. As the process of re-anchoring inflation expectations became clearer, a second phase started, in which the central bank eased monetary conditions at a relatively fast pace, leading to the current 7% level for the Selic rate.

Looking forward, Governor Goldfajn argues that the trajectory of inflation is already pointing in the direction of the target in 2018, as suggested by the rise of 0.49 p.p. of 12-month inflation at the end of 2017 relative to the bottom reached in august of the same year. He also emphasizes that the projections of the central bank (conditional on the Focus Survey path for the Selic rate and exchange rate) indicate the inflation rate will reach 3.2% by the end of the first quarter of 2018, above the 3% lower limit of the tolerance band. This creates an important guidepost: if inflation is significantly below the floor of the tolerance band in March, the central bank may add further to the monetary stimulus. For the moment, we stick to our call that the central bank will cut the Selic rate by 25bps in February and again in March, but we concede that this fin al cut has become less likely after the higher-than-expected IPCA reading.

Traffic of heavy vehicles rose 3.4% mom/sa in December (our seasonal adjustment), up 1.5% yoy. The December figure offsets declines in both October and November and leads the 3-month moving average to rise 0.3%.

Paper cardboard dispatches (ABPO) rose 1.4% mom/sa in December (our seasonal adjustment). The strong figure leads the 3-month moving average to increase 0.5%, and resumes the slightly positive trend interrupted in the previous two months.

These figures are in line with other coincident indicators already released, signaling a strong industrial production in 4Q17. We forecast industrial production grew 1.6% mom/sa in December.


Central bank surveys of both traders and analysts still show that the median consensus is for steady rates before one 25-bp hike in 2H18 to 2.75%. Analysts still see the policy rate reaching 3.25% by the end of 2019, while traders now expect a more gradual normalization process with only one further hike in 2019 to 3.0%. Analysts’ one-year inflation expectation is at 2.6% (previously 2.7%) while still anchored at the 3% target for the relevant 2-year horizon. A total of 36% of respondents see inflation below 3% in 2 year’s time, up slightly from 33% in December. Meanwhile, there is an improved growth outlook to 3.2% for this year (3% previously) and 3.5% next year (3.3% previously). Traders view inflation in two years well below the 3% target at a 2.8% median (unchanged from December), with the breakdown showing 30% of respondents see inflation above 2.8% and closer to the target (down from 37% a few weeks earlier). While the central bank has validated its stay on hold baseline scenario, it has raised concern with some inflation expectation measures that are below the 3% target and will continue to evaluate whether the target convergence of inflation is threatened. We expect stable rates this year as inflation remains low and the activity recovery moves to consolidate. Next year rates hikes to 3.5% are consistent with the expectation that the output gap narrows.


Today, the INDEC (the official statistical agency) will publish the National CPI for December at 4:00 PM (SP time). Headline inflation rose by 1.4% month over month in November (1.3% for the core reading), accumulating 21.0% year-to-date. According to private estimates (Elypsis), headline inflation accelerated to 2.5% month over month in December due to the impact of the adjustment in regulated prices (energy tariffs). If this estimation is correct, headline inflation in 2017 will reach 24%. As a consequence, the central bank will likely miss the target range set for last year by seven points.


INEGI will publish November’s industrial production today at 12:00 PM (SP time). We estimate industrial production fell 1.7% year-over-year (from a 1.1% contraction in October), considering weaker coincident data.


The Central Bank of Peru (BCRP) will announce the reference rate today at 10:00 PM (SP time). With annual inflation ending 2017 at the lowest level in almost eight years (1.4%, from 1.5% in November) – below the BCRP’s 2% target – and the political crisis posing a negative risk on activity, we believe the board will cut the reference rate by 25bps. The majority of analysts surveyed by Bloomberg also expect the BCPR to reduce the policy rate to 3%. Even though activity is improving gradually, recent comments from members of the board confirm they view the deterioration of the domestic political scenario as a threat for the economic growth outlook.

Fuente: ITAU

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