Inflation expectations rise in Brazil ahead of World Cup, elections

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Brazil‘s President Dilma Rousseff’s official portrait

Despite Brazil’s strenuous efforts to combat rising prices, inflation expectations continue to move upward as the market speculates the central bank will refrain from raising interest rates a tenth consecutive time at its policy meeting next week in a bow to political pressures ahead of October presidential elections.

Brazil’s central bank has raised the Selic, the benchmark interest rate, by 3.75 percentage points over the past year to 11 percent, in a bid to curb inflation. The country’s consumer price index rose 6.28 percent in the 12 months through April, nearing the upper limit of the government’s 6.5 percent inflation target band.

“I can’t imagine they are going too much further (with the Selic),” said Werner Baer, the Jorge Lemann Distinguished Professor of Economics at the University of Illinois Urbana-Champaign, in an interview, especially amid strong political pressure to suspend rate hikes.

“The increase of the interest rate would increase the burden of the debts people are carrying and people are much more indebted than they were a few years ago,” Baer said. “This would also cause the threat of a substantial short-term capital inflow, which would tend to further appreciate the currency, the real, and hurt domestic industries.” 

Heavier debts, capital inflows and weaker economic growth are definitely not what President Dilma Rousseff, whose popularity hit a record low in 2013, would want to see as she is seeking re-election in October. 

Under her term, Brazil’s economic growth has plummeted, with real GDP falling from 7.9 percent in 2010 to a low point of 1.03 percent in 2012, before rebounding to 2.28 percent in 2013. 

But suspending rate hikes to boost the economy may not give Rousseff’s administration a boost in popularity, as inflation-weary Brazilians have felt the pinch and taken to the street. Sao Paulo police officers joined bus drivers Wednesday to halt services and protest for better salaries, another strike among many that are breaking out nationwide.

With the World Cup less than a month away, many fear that a surge of foreign tourists will shore up prices at restaurants and hotels, worsening the inflation spike.

“(The government) will keep using all means not to breach the 6.5 percent threshold, like providing subsidies to keep private prices low and not allowing public prices to rise,” said Márcio Garcia, associate professor at the Pontifical Catholic University at Rio de Janeiro, Brazil, in an email exchange. “The worst is to force Petrobras to subsidize gasoline.” 

To rein in inflation, Rousseff has been using Petrobras, Brazil’s state-run oil producer, to subsidize oil imports since 2011. The company reported a 30 percent drop in net income in the first quarter.

Given the lack of formal central bank independence in Brazil, Garcia believes the next President should make a point of granting the necessary autonomy for the BCB to pursue the inflation target.

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