Campos Neto says in a letter to Guedes that double-digit inflation is the fault of a global phenomenon

In an open letter released this Tuesday (11), the president of the BC (Central Bank), Roberto Campos Neto, attributed the bursting of the inflation target in 2021, which accumulated a rise of 10.06%, to successive shocks in costs and emphasized that this is a movement observed in other countries as well.

“In fact, the significant acceleration of inflation in 2021 to levels above the targets was a global phenomenon, affecting most advanced and emerging countries,” said the text, addressed to the Minister of Economy, Paulo Guedes.

In the decomposition of the 2021 index, according to the BC, the so-called “imported inflation” was the one that most contributed to the indicator being outside the target, with a weight of 4.38 percentage points. Then came the inertia of the previous year (1.21 points) and 1.02 points for other factors.

The flag of water scarcity, which made the Brazilian electricity bill more expensive, represented 0.67 points.

“The main factor for the deviation of 6.31 pp of inflation in relation to the target came from imported inflation, with a contribution of 4.38 pp, about 69% of the deviation. Opening this term, the contributions of 2, 95 pp from the price of oil, 0.71 pp from commodities in general and 0.44 pp from the exchange rate”, highlighted the letter.

On the other hand, the output gap (when the economy is below its potential) held back inflation, with a negative contribution of 1.21 points.

Inflation for the period, which was released this morning by the IBGE (Brazilian Institute of Geography and Statistics), closed at double digits and was well above the target set by the CMN (National Monetary Council), of 3.75%, with a tolerance of 1 .5 percentage point up or down. The indicator could reach a maximum of 5.25%.

The increase is the biggest for the period from January to December since 2015, when prices accelerated 10.67%. At the time, the national economy was going through a period of recession under Dilma Rousseff (PT) government.

Whenever inflation ends the year outside the determined range, the BC president needs to justify the reasons in an open letter and detail how the problem should be resolved. This is the sixth since the creation of the inflation targeting system in 1999.

According to the document, the rise in the IPCA (Extended National Consumer Price Index), the country’s official inflation, was driven by several shocks, such as the rise in commodity prices along with the depreciation of the real, a flag of water scarcity in electricity and imbalance between demand and supply of inputs, in addition to bottlenecks in global production chains generated by the Covid-19 pandemic.

“Pressures on commodity prices and on global production chains reflect the changes in consumption patterns caused by the pandemic, with a proportionately larger share of demand directed to goods and driven by expansionary policies. [juros mais baixos]”, said the BC.

“These developments, which took place on a global level, generated excess demand in relation to the short-term supply of various goods, causing an imbalance that, in several countries and sectors, was exacerbated by lack of manpower, logistical problems and bottlenecks of production,” he continued.

According to the BC, the exchange rate had a smaller contribution to inflation in 2021 compared to the previous year, but the dollar reached, in December last year, an average 9.83% higher than that observed in the same period of 2020.

Campos Neto attributed the depreciation of the Brazilian currency to the increase in fiscal risk, when economic agents understand that there may be a maladjustment in public accounts.

“The downward trend [cambial] in the second half of 2021 mainly reflected questions regarding the future of the current tax framework and the increase in risk premiums associated with Brazilian assets, given the greater uncertainty surrounding the future trajectory of sovereign debt”, he explained.

The BC president also emphasized that Brazil has historically benefited from high commodity cycles because it is an exporter of inputs, so the local currency is appreciated in these periods.

This time, however, the prices of these products rose at the same time that the real depreciated, which pushed prices up even further within the country.

“Although the contribution of the exchange rate to inflation was lower than in 2020, it is worth noting the break in the historical pattern of appreciation of the national currency during cycles of rising commodity prices, such as occurred in the last eighteen months. As a result, the growth of IC-Br [índice de commodities] and the price of oil measured in local currency was amplified, reaching 50.3% and 82.9% in the year, respectively, when comparing the average of the last quarter of 2021 with the same period of 2020, both of which are the biggest changes since the beginning of its historical series”, stressed the text.

The head of the monetary authority also stressed that services were affected by the pandemic and social distancing, which held back inflation in the sector in 2020. After the reopening of the economy, however, demand grew and prices rose.

“The significant increase in social distancing with the outbreak of the pandemic meant a sharp reduction in demand for services in 2020, leading to five monthly deflations in a six-month period (between March and August 2020) and the historic minimum of variation of 0.95 % YTD in August 2020, closing the year at 1.73%,” the letter said.

“However, as social distancing has eased, driven by significant progress in Covid-19 vaccination, the reactivation of the services sector has led to a realignment of prices, implying an acceleration of services inflation to 4.75% in 2021. In other words, a portion of services inflation in 2021 is related to the normalization, in terms of prices, that were depressed as a result of the specific impacts of the health crisis”, he justified.

The BC also said that with the “extension of some fiscal aid programs implemented in 2020, demand – mainly for goods – remained sustained during 2021, reinforcing price pressures in segments with limited supply or logistical bottlenecks”.

In the document, Campos Neto reiterated that, to bring inflation back to the target in the relevant horizon (2022 and 2023), for when the municipality understands that monetary policy is effective, the BC has calibrated the basic interest rate (Selic) ” and will continue to do so.”

The previous letter was written by Campos Neto’s predecessor, Ilan Goldfajn, in January 2018. The text was related to 2017 inflation, but, at the time, the then BC president was justified by a result slightly lower than the established minimum.

The others were written in 2015, 2003, 2002 and 2001, all due to having exceeded the upper limit of the inflation target. Since the implementation of the regime, all BC presidents have had to justify non-compliance with the target.

Last month, the Central Bank’s Copom (Monetary Policy Committee) raised the base rate again by 1.5 percentage points, to 9.25% per year. In the statement, the BC indicated a new high of the same magnitude for the next meeting, in February, to 10.75% per year.

In 2020, the BC took the basic interest rate to the lowest level in history, at 2% per year in August, and maintained the level until March 2021. The “extraordinarily stimulating” level, as classified by the Copom at the time, was accompanied by of the BC’s communication that inflation was temporary, which led expectations to rise over the course of last year.

Campos Neto claimed that the outbreak of the pandemic and “its strong disinflationary effects” led the BC to reduce the Selic rate to an all-time low.

“In parallel, several measures were taken involving liquidity, capital and credit to counteract the effects of the pandemic. Copom stressed that, at that moment, the economic situation prescribed an extraordinarily high monetary stimulus, justified both by Copom’s projections and by market expectations. “, he argued.

The stimulus level, according to the BC, went beyond the reduction of the Selic rate to 2% per year. “Forward guidance was also adopted [compromisso de não subir juros] from August 2020, with signs that monetary policy would be extraordinarily stimulative while BC projections and inflation expectations remained significantly below target,” the letter said.

The document highlighted that inflationary surprises emerged at the end of 2020.

“Among the surprises is the elevation of the electricity tariff flag from green in November to red level 2 in December, an unusual level at the end of the year, with an impact of around 0.42 pp on 2020 inflation”, he stressed.

“It is worth noting that the economic scenario of recovery after the Covid-19 pandemic has been marked by uncertainty and volatility above the usual, which has been reflected in inflationary surprises around the world”, claimed the BC.

The monetary authority reiterated that the Copom adopted a contractionary stance, which resulted in an increase in real interest rates (discounting inflation) from -1.3% in the last quarter of 2020 to 4.4% a year in the last quarter of 2021.

“On this trajectory, the real rate increases to 6.3% and 6.4% in the first and second quarters of 2022, respectively. The increase in the real rate in this cycle is the largest that occurred during the inflation targeting regime,” he said. .

Once again, the BC linked the increase in inflation expectations to fiscal risk.

“Questions regarding the future of the fiscal framework result in an increase in risk premiums and increase the risk of de-anchoring inflation expectations. This implies assigning greater probability to alternative scenarios that consider higher neutral interest rates”, he said.

The letter points out that the BC’s projections are that inflation will start on a downward trajectory in early 2022, ending the year at a significantly lower level than 2021.

The municipality’s expectations are for inflation of 4.7% in 2022, 3.2% in 2023 and 2.6% in 2024, against inflation targets of 3.50%, 3.25% and 3.00%, respectively.

“In this scenario, in 2022, inflation still remains above the target, although within the tolerance range, due to the inertial effects of inflation in 2021”, he pointed out.

The text also reaffirmed the harsher tone adopted at the last meeting, signaling that Copom will raise interest rates “until not only the disinflation process is consolidated, but also the anchoring of expectations around its targets”.

Campos Neto is now working with the risk of failing to meet the target for the second year in a row in 2022, set at 3.5% with a tolerance of 1.5 percentage points. For the period, the market already expects the indicator to be above the maximum allowed in the tolerance range, which is up to 5%.

According to this week’s Focus report, in which the BC releases expectations from economists at financial institutions and analysis houses, prices are expected to rise by 5.03% this year.

Longest-running representative so far, Henrique Meirelles was the only BC president to have to write two letters during his term, which lasted from January 2003 to December 2010, eight years in all.

Campos Neto began his term in February 2019 and is now in his third year in charge of the municipality.

This is the first letter written after the approval of BC’s autonomy, which defined secondary objectives for the autarchy. In addition to inflation, which remains the main attribution, the authority needs to look at economic activity and the labor market.