June deflation reinforces pressure on the Central Bank to reduce interest rates

Agência Brasil – The decrease in the official inflation rate in June, announced this Tuesday (11th) by the Brazilian Institute of Geography and Statistics (IBGE), is seen as a pressure element for the Monetary Policy Committee (Copom) of the Central Bank (BC) to begin a cycle of interest rate cuts, starting in August. This is the opinion of economists interviewed by Agência Brasil.

The National Broad Consumer Price Index (IPCA) was -0.08% last month. It was the lowest index for a June since 2017. The food and beverages and transportation groups were the ones that most contributed to pushing prices down last month.

"Inflation has been on a downward trajectory since February, and the 12-month accumulated rate is at 3.16%, right in the center of the inflation target. Since the Selic rate is meant to achieve this target, the demand for a reduction should gain strength," says Professor Jorge Claudio Cavalcante, from the Department of Economic Analysis at the Faculty of Economic Sciences of the State University of Rio de Janeiro (UERJ).

Economist Fabio Bentes from the National Confederation of Trade in Goods, Services, and Tourism (CNC) considers the IPCA result a "pleasant surprise." "I was expecting stability or a slight decrease, but it came out as a stronger decline than expected," he evaluates.

According to André Braz from the Brazilian Institute of Economics at the Getulio Vargas Foundation (Ibre/FGV), there are three main factors putting pressure on the monetary authority. One of them is the diffusion index, which measures the percentage of products and services that have experienced price increases. This index has been declining. "In June, it dropped to 50%. Two or three months ago, it was around 60%, so this shows that fewer products and services have seen price increases, which is a good sign," he points out.

Another factor, according to Braz, is the so-called core inflation. "The core inflation has the task of measuring the true trend of inflation, and despite being far from the target, it is showing deceleration, which also anticipates that inflation is indeed undergoing a reduction," he analyzes.

The economist also highlights the behavior of food prices. "This is good because it shows that where the most vulnerable population feels the inflation the most, the IPCA is also losing momentum. This deflation process that starts with food favors the condition of the monetary policy itself [interest rate control]. I would say that we have the elements for a first interest rate cut at the August [Copom] meeting," Braz points out.

Economist and professor at Ibmec, Gilberto Braga, believes in a consensus for interest rate cuts but points out a warning sign that could limit the size of the cut.

"There has been an increase in the price of services, which is an extremely relevant sector in the inflation composition. It is the only negative point that can be seen in this June's IPCA. This rules out, in my view, a larger reduction than 0.25 percentage points," he evaluates.

Consumer's pocket – Although the food and beverages group had the greatest impact on the decline in prices in June, Professor Jorge Claudio Cavalcante from UERJ explains that the population may not necessarily have felt this relief in their pockets yet. "We should expect a more pronounced drop before people begin to feel relief," he predicts.

Highlighting that the June IPCA showed a 8.96% decrease in the price of soybean oil, economist Ricardo Caldas, a professor at the University of Brasília (UnB), points out that consumers gain purchasing power. "It is a quite substantial decrease and will certainly reflect in purchasing power because consumers who save on soybean oil will spend that extra money on other things."

"The general perception, when comparing from a longer-term perspective, is that food is still expensive, which is indeed confirmed because they have been the villains of inflation since the pandemic. Those who do frequent shopping notice that some items have become cheaper. But those who do not go to the markets regularly and have price memory still have a sense that everything is very expensive," says Gilberto Braga.

Copom - Professor Marco Antônio Rocha from the Institute of Economics at the State University of Campinas relativizes the pressure that June's negative inflation may have on Copom.

"Deflation is very concentrated in items of the IPCA that respond little to monetary policy [interest rates]. Food prices are determined by the market, and transportation prices are administered, so in essence, monetary policy had little relation to this deflation," he evaluates.

The Copom holds meetings every 45 days to decide on the basic interest rate. Currently, the Selic is at 13.75%, under the justification that it is necessary to combat inflation. At the end of the most recent meeting on June 21st, the Copom issued a statement to explain the decision: "The committee assesses that the conjuncture demands patience and serenity in the conduct of monetary policy and reminds that future steps of monetary policy will depend on the evolution of inflation dynamics, especially those components most sensitive to monetary policy and economic activity, inflation expectations, particularly longer-term expectations, inflation projections, the output gap, and the balance of risks," the note emphasizes.

High interest rates are a way to control inflation as they discourage consumption and make credit more expensive. However, they are more recessive, affecting economic growth and job creation. That is why the government, businesses, and labor unions have been pressuring for a reduction in the Selic.

The next Copom meeting will be on August 1st and 2nd. Ricardo Caldas from UnB points out that, in addition to the recent deflationary scenario, a change in the composition of the committee increases the pressure for a reduction in the Selic. The Senate approved the names of two new directors appointed by the government of President Luiz Inácio Lula da Silva at the beginning of the month. "The board is no longer solely made up of appointments from the previous government. With this, the thesis of interest rate reduction also gains strength within the Central Bank," he explains.

Economist Fabio Bentes from CNC highlights that the country is experiencing the lowest accumulated inflation in 12 months since September 2020, at the height of the pandemic. "Therefore, this opens up room for some inflection in the monetary policy of the country," he says. According to him, the fact that food prices are trending downward suggests that a change in the Central Bank's stance will not be limited to just one reduction in the Selic rate, but rather several reductions.

"[The downward trend in food prices] is great because it tends to make inflation throughout this year continue to move toward the center of the target. This should lead the Central Bank to begin implementing a series of interest rate cuts. Of course, the Central Bank does not look at June's inflation, nor does it look at the inflation of 2023 anymore; it looks at the inflation of 2024. And the expectation for IPCA in 2024 is already within the inflation target range," he emphasizes.

The inflation target for this year is 3.25%, with a variation of 1.5 percentage points up or down. For 2024 and 2025, the government's target is an IPCA of 3%, with the same variation range.

Upcoming months - Although they see room for the Copom to cut interest rates, economists do not necessarily believe that there will be further negative results throughout 2023. "I don't think we should expect new deflations. For example, without the decrease in the price of new cars, the IPCA would have an increase in the range of 0.05%," estimates Cavalcante from UERJ.

"We have been seeing the price deceleration process since January. This should continue in the coming months. This decline will not necessarily generate deflation, but everything indicates that we will have a price index in 2023 that is lower than that of 2022 [5.79%], and the market is already betting on inflation in 2023 being below, that is, within the target," explains Caldas from UnB.

Economist André Braz from Ibre/FGV estimates that gasoline prices will increase in July due to the reintroduction of federal taxes. However, he does not expect significantly negative effects on overall inflation.

"We are seeing a more widespread inflation deflation, especially among food products. Cheaper food benefits families, especially the poorer ones, who allocate a larger portion of their income to food purchases. This shows that the inflationary process will be less harsh on families with less defense," he says.

Gilberto Braga from Ibmec points out that the controlled behavior of prices, such as health plans and public transportation, electricity, and water tariffs, will still continue to contribute to inflation. "We have important contract anniversaries, public transportation fare adjustments in some capitals, and when you look at the inflation over 12 months, you recall these adjustments. That is one of the reasons why you don't drastically bring down inflation from one moment to another," he explains.

Professor Marco Antônio Rocha from Unicamp also believes that IPCA will end the year within the upper limit of the Central Bank's target. However, he emphasizes that Brazil is also exposed to risks that do not depend on Brazilian monetary policy. "There may be other pressures that arise along the way, for example, climate issues make the situation of food prices very uncertain. There are international disturbances in the conflict zone in Ukraine, which can affect the international market, and there is also the behavior of the American economy, which seems to be gaining strength," he enumerates.

The controlled behavior of IPCA and the expected cut in the Selic rate are, according to Fabio Bentes from CNC, drivers for economic growth. "We don't have major price pressures on the horizon that would warrant an excess of caution on the part of the monetary authority. We should end the year with a Selic rate around 12%, which is still very high, but the tendency is the beginning of a process of easing and, by the end of 2024, perhaps a Selic rate close to 9%. We will possibly be facing a new cycle of economic expansion."