Pandemic bottlenecks make change in inflation target justifiable, say economists

Amidst President Lula’s criticism of the Central Bank’s monetary policy, the discussion around a new inflation target has gained strength, especially after BC President Roberto Campos Neto signaled that he could increase the target of 3.25 % to 3.5% this year.

The possibility did not please the market, which is reflected in the rise of the dollar and the fall in the Ibovespa, but economists say that the change may be a “viable” option at the moment.

For Paulo Gala, chief economist at Banco Master, changing the target is a more appropriate solution to reduce tension between the government and the municipality, without causing more relevant friction and negative impacts on the economy.

“It seems to me that this is the easiest way to resolve this imbroglio, because I don’t think the government will change the Central Bank’s autonomy and independence law, because it would depend on Congress, and I think it’s very difficult for them to pass that. In addition, I also think it is unlikely that anything will happen to Campos Neto until the end of his term at the head of BC, I think he will stay. Therefore, the most natural path is to change the inflation target, which is really very low, ”he said.

The economist pointed out that it is important to analyze the context in which the target was initially set. The National Monetary Council (CMN) set the inflation target at 3.25% for 2023, with a tolerance of 1.5 percentage points up or down in mid-2020. due to the disruptions in the supply chains caused by Covid-19, they led to an increase in prices in Brazil and in the world.

“Before the pandemic, we were in a period of very low inflation in the world. In the US, it was below 2%, while in Brazil it was slightly higher, at around 3% per year. It was a scenario of no inflation in the world, but after the pandemic, that changed completely. We are talking about inflation in the USA and Europe of 10% a year, which had not been seen since the 1980s”, explained Paulo Gala.

“For an emerging economy like Brazil, an inflation target of 3% is very difficult to achieve. The level of sacrifice is very high, interest rates have to stay at the top and strangle the economy a lot. So, I think the government will mobilize and move towards a change in the target for next year, eventually 3.5% or even 4% and, thus, freeing up the Central Bank a little to make a more accommodative monetary policy, more expansionist”, he added.

In the view of Alexandre Espírito Santo, Chief Economist at Órama, changing the target is a viable alternative, but it should be done out of necessity and based on strong analyses, and not as a result of hasty pressure.

“I don’t believe it’s good to change the targets in the face of political pressure, but it seems to me unlikely that it won’t happen. Changing the target because a cataclysm has occurred, such as a catastrophe, a pandemic, is acceptable, but at that moment it will seem like casuistry, it seems that it is because of this political demand, even if it is not”, said the economist.

Espírito Santo also reinforced that the consequences brought about by the pandemic are preponderant factors for the evaluation of alterations in the BC’s target objective, and also considered lengthening the space of the target ceiling.

“It is very likely that there will be changes. In my opinion, if it were to be done, the best thing would be to change the center a little, to 3.5%, and return with a larger interval of around 2%, giving more degrees of freedom and allowing for a drop towards the end of the year. Now, none of this will go ahead without the new fiscal rule: this is where expectations may or may not be more strongly affected, even more so than the eventual change”, he declared.

According to experts, the lack of definitions and attacks by members of the Executive on the BC contribute to increasing expectations about inflation in 2023 and 2024, which would be “a shot in the foot” in the strategy of cutting interest rates and controlling rising prices in the future.

Marília Fontes, founding partner and Fixed Income analyst at Nord, assesses that the drop in inflation indicators in the country should be causing expectations to fall, which would mean that the BC would have room to reduce the Selic rate in the second half this year, as it would discourage expectations.

“In this sense, inflation expectations end up influencing a lot, because companies readjust their prices based on them. And expectations are rising precisely because the government is creating friction with the Central Bank, talking about increasing spending, financing neighboring countries through the BNDES… all of this makes the market worsen inflation expectations”, he declared.

Nicolas Borsoi, from Nova Futura Investimentos, points out that in the current scenario the Selic should remain stable at 13.75% throughout 2023, but draws attention to the impact of the fiscal framework proposed by Haddad, which, if credible, it can guarantee the return of the primary surplus as of 2024 and the control of the public debt in the coming years, leading to falls in the exchange rate and in inflation expectations.

“Thinking about alternative scenarios, I believe there are two other factors that could justify a cycle of cuts ahead: if global commodity prices fall due to expectation or the onset of a global recession. Or, less likely, if the central banks of developed countries reverse their current monetary policy, starting the cycle of cuts in the 2nd half, which would appreciate the real, opening space for the Copom to reduce the Selic rate”, he said.