Brazil's Inflation Shifts From Vicious Cycle to Virtuous Circle

  • Price adjustments from rent to internet tied to indexes
  • Analysts see Brazil inflation below target this year and next

Pegging prices to inflation in Brazil used to result in a vicious cycle of rising costs. Nowadays it’s become a virtuous circle.

Indexation -- the practice of writing automatic price hikes into contracts for everything from rents to Internet packages -- is perpetuating lower-than-expected inflation as the consumer price indexes those contracts track have fallen.

The current trend represents a dramatic shift from just two years ago when the same feature had the exact opposite effect, driving consumer prices to their highest level in over a decade. With inflation seen below target both this year and next, financial markets have backed off bets that the central bank would have to start tightening monetary policy later this year as growth picks up. Another rate cut’s looking likely at the bank’s monetary policy committee meeting on Wednesday while the chances of a hike before 2019 are starting to fade.

"With the indexation of contracts, there’s room for beneficial inflation inertia through the end of the year," Jason Vieira, chief economist at Infinity Asset Management, said in an interview. "This reduces the impact of consumer prices in the medium-term, and may challenge the idea of raising borrowing costs this year."

Indexation Lends a Hand

Price measure used to adjust rental contracts has dropped more than official cost of living

Brazil national statistics agency IBGE, FGV

Speaking to Bloomberg News on the fringes of the G-20 summit in Buenos Aires on Tuesday, Brazil’s Finance Minister Henrique Meirelles acknowledged that indexation was far from optimal. "Ideally, at some point this becomes a matter of free negotiation like in other countries," he said. "That way you could even lower prices, in a recession for example."

Annual inflation has crept below the floor of the official target range for eight straight months, and analysts in a weekly survey see consumer prices inching up to 3.63 percent in December before reaching 4.20 percent at the end of 2019. The midpoint of the central bank’s target range is 4.50 percent this year and 4.25 percent next year.

Central bank President Ilan Goldfajn said this month that inertia may lead to an inflation outlook that’s lower than previously thought.

All signs point to the monetary authority cutting the benchmark Selic for the 12th straight meeting at its rate-setting decision on Wednesday, Vieira said. Traders in the interest-rate futures market aren’t fully pricing in any increase in borrowing costs until January, compared to their expectation three months ago of a monetary tightening starting this September.

While policy makers have the wind at their back now, the consumer price outlook could change on a dime should the next president not be as market-friendly, according to Zeina Latif, chief economist at XP Investimentos Cctvm. In early polls for this October’s election, pro-business candidates are lagging behind contenders who are critical of the current administration’s austerity policies.

"Inertia is helping today, as inflation and salary increases are low, but this is not a guarantee in the future," Latif said in an interview. "This is very contingent on the expectation that the next president will continue with reforms."

— With assistance by Raymond Colitt

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