Inflationary Optimism?
Forecasters had a difficult time adjusting their models to the pandemic. Predicting inflation is an example: it was not even certain in the beginning whether the pandemic would be inflationary or disinflationary. From January through May, disinflation prevailed in Brazil. As shown in Figure 1, the sharp contraction in activity in the second quarter of 2020 led to a big drop in 12-month inflation, followed by an equally substantial downsizing of inflation forecasts for the year.
Figure 1: 12-month inflation and mid-month forecast for 2020 inflation (IPCA) (%)
Sources: IBGE and Central Bank.
Throughout, however, the median forecast underestimated 2020’s inflation rate. Indeed, the IPCA, Brazil’s main consumer price index, surprised once again upwards in December: a rise of 1.35%, against an expectation of 1.21%. In October (0.86%, against a forecast of 0.80%) and November (0.89% and 0.77%, respectively) was the same thing: forecasters were too optimistic about inflation. The year closed with inflation at 4.52 percent, above the Central Bank’s inflation target of 4.00 percent.
Individual components of the IPCA behaved in rather different ways in 2020. Table 1 reveals that the sharp rise in food prices (15.1% of the index), as a result of higher international food prices and a weaker currency, accounted for 3/5 of the rise in the IPCA last year. The increase in the price of industrial goods (23.1% of IPCA), which also reflected the currency's devaluation, was less significant, being mitigated by weak domestic demand.
Table 1: Change in IPCA and its components in 2020 (%)
Inflation |
Contribution to annual inflation (p.p.) |
||||
1st quarter |
2nd quarter |
2nd semester |
Complete Year |
||
IPCA |
0.53% |
-0.43% |
4.4% |
4.5% |
|
Regulated prices |
0.02% |
-2.18% |
4.9% |
2.6% |
0.67 |
Non-regulated prices |
0.74% |
0.21% |
4.2% |
5.2% |
3.87 |
Services |
0.91% |
-0.48% |
1.3% |
1.7% |
0.63 |
Air tickets |
-27.69% |
-37.95% |
84.6% |
-17.2% |
-0.08 |
Other services |
1.49% |
0.06% |
0.5% |
2.1% |
0.75 |
Foodstuff consumed |
1.66% |
3.04% |
12.8% |
18.2% |
2.74 |
Industrial goods |
-0.05% |
-0.43% |
3.7% |
3.2% |
0.73 |
Source: IBGE and FGV/IBRE.
Air tickets (0.4% of the IPCA) fell in price, due to the collapse of demand and cheaper oil. Meanwhile, the prices of other services (35.9% of the index), not very sensitive to the exchange rate, and much affected by the drop in demand, went up just 2.09 percent, way less than the average of 5.2 percent registered in the previous five years.
Finally, with the fall in the price of oil, the freezing of health insurance premiums, discounts in school fees and moderate rises of public transport fares, regulated prices (weight of 25.5%) rose 2.62 percent, a fraction of the annual average of 8.6 percent recorded in the previous five years.
The pace of inflation varied greatly through the year. In the first half, consumer prices rose a mere 0.10 percent, in the second, an amazing 4.42 percent. This difference will greatly influence the dynamics of 12-month inflation going forward. As shown in Figure 2, which relies on the median of projections collected by the Central Bank in the Focus Bulletin, Brazil should go through two distinct phases in 2021:
- In the first half, when higher inflation rates will substitute for the low monthly inflation rates of the first half of 2020, 12-month inflation will rise further, hitting 6.16 percent in May, the highest rate since December 2016. Inflation would stay around that level for another three months.
- From September onwards, 12-month inflation would drop sharply. In the year, the IPCA is projected to rise 3,34%, slightly less than forecasted for 2020 at this time a year ago (Figure 1).
Figure 2: 12-month inflation
Sources: IBGE and Central Bank.
For inflation to drop this year, non-regulated prices will have to rise less than in 2020, as regulated prices are expected to rise much more, as there will be no price freezes, discounts will be withdrawn and fuel prices will go up as oil prices rise. If the Central Bank is right, and these prices rise by 5.7 percent in 2021, non-regulated prices will have to go up by only 1.4 percent, if the IPCA is to increase by 3.34 percent in the year. Reasonable or too optimistic?
Hard to tell. International commodity prices are not expected to fall this year, nor is a substantial exchange rate appreciation in the cards. Indeed, the more likely scenario is for commodity prices, including that of foodstuffs, to remain stable or decline only modestly when measured in domestic currency. Thus, for non-regulated prices to rise 1.4 percent in 2021 it will be necessary that:
- Vaccination in Brazil does not advance sufficiently fast this year, so private sector demand fails to recover more substantially in the second half of the year, especially in the case of services.
- Inflation expectations remain tamed, not being influenced by the high level of 12-month inflation of mid-2021.
If one or both of these premises fail, inflation risks to once more surprise on the upside and surpass the Central Bank’s target for the year (3.75 percent). This suggests that the Central Bank's position may be less comfortable than it seems, given current inflation forecasts. In particular, it is not possible to be optimistic about the control of the pandemic and the recovery of the economy in the second half of the year, without at the same time worrying about the dynamics of inflation in 2021.