Food Price Drop Provides Relief in Brazil Inflation Fight

The first decline in food prices in two years provided temporary assistance to Brazilian President Dilma Rousseff’s efforts to tame inflation being pressured by the biggest currency slide among emerging markets.

Prices as measured by the benchmark IPCA index rose 0.03 percent in July, in line with analysts surveyed by Bloomberg whose median forecast was for prices to remain unchanged. Cheaper food costs, as well as declines for transportation and clothing, lowered 12-month inflation, which had exceeded the 6.5 percent upper limit of the government’s target range, to 6.27 percent.

Finance Minister Guido Mantega celebrated today’s reading, saying it shows that inflation remains under control in the world’s second-biggest emerging market. Banco Merill Lynch SA forecast monthly inflation will rebound as a rallying dollar puts pressure on companies to raise prices even as policy makers have embarked on the biggest cycle of interest rate increases in the Group of 20.

“This is likely just a transitory respite,” Zeina Latif, a partner at Sao Paulo-based Gibraltar Consulting, said in a phone interview. “The combination of a very strong devaluation, and the limited space by companies to reduce margins further after absorbing rising salary costs the past few years, means that the pass-through to consumers is likely to be significant.”

Real Plunge

The real has plunged nearly 13 percent over the past three months, more than any major emerging market currency, as a wave of street protests over rising bus fares further dim the country’s growth outlook.

The currency weakened 0.2 percent to 2.3041 per U.S. dollar at 10:54 a.m. local time. Swap rates on the contract maturing in January 2015, the most traded in Sao Paulo today, fell three basis points, or 0.03 percentage point, to 9.68 percent.

While a weaker jobs market and high consumer indebtedness may help restrain inflation, the currency has room to weaken further as the Federal Reserve considers rolling back its bond-buying program on signs the U.S. economy is improving, Latif said.

Fair Price

The average real effective exchange rate over the past two decades, taking into account inflation and the currency’s value against those of Brazil’s trading partners, is around 2.40 reais per dollar, she said.

“While the currency depreciation has been sudden you can’t argue that there’s been overshooting,” she said.

The weakening currency led the government to cut tariffs this month on more than 100 imported products, including basic materials such as steel.

The central bank also raised the benchmark rate by 50 basis points to 8.5 percent in July following a 75-basis-point boost between April and May. Traders expect policy makers to raise rates to 9 percent this month, swap rates show.

The slide in the real is “avoiding an important decline in inflation expectations, despite the ongoing increase in interest rates,” David Beker, the chief Brazil economist at Banco Merrill Lynch SA, wrote in a note to clients today.

Economists expect inflation to accelerate to 5.87 percent in 2014 from 5.75 percent this year, according to the median forecast in a central bank survey published this week.

Food prices dropped 0.33 percent in July, clothing prices fell 0.39 percent and transportation costs contracted 0.66 percent, the Rio de Janeiro-based statistics agency said.

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