Itaú BBA - Evening Edition – Higher-than-expected inflation in Brazil

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Evening Edition – Higher-than-expected inflation in Brazil

April 10, 2019

Notwithstanding the elevated headline result for March, core inflation measures remain on a very comfortable path.

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IPCA inflation increased 0.75% in March (from 0.43% in the previous month), above our call and the market's expectations (both at 0.63%). In year-over-year terms, inflation printed a 4.58% increase (our call and the market’s: 4.45%), from 3.89% in February. Compared to our expectation, food at home and transportation prices surprised to the upside, adding 8 and 4 bps to the deviation from our call, respectively. The diffusion index (which measures the share of products with positive price changes) reached 65.3% in the month (from 59.0% previously).

Notwithstanding the elevated headline result for March, core inflation measures remain on a very comfortable path. The underlying service inflation indicator advanced 0.2% during the month and 3.3% yoy. We maintain our assessment that inflation is sustaining a benign dynamic and is subject to low risk of demand-side pressures. This outlook is also supported by inflationary inertia, anchored inflation expectations and substantial slack in the economy. Our estimate for the full year IPCA remains at 3.6%.
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On economic activity, two coincident indicators for March’s industrial production released today reaffirm weak activity. Paper cardboard dispatches (ABPO) and traffic of heavy vehicles (ABCR) have both posted declines in March. Using our seasonal adjustment, we estimate a 2.6% and 0.4% mom/sa decrease in ABPO and ABCR in the period. Our preliminary forecast for March’s industrial production declined to -0.9% mom/sa (-5.4% yoy) from -0.8%. Importantly, the weak year-over-year forecast reflects a lower number of working days in March, as Carnival 2019 was celebrated in the month, while the holiday in 2018 happened in February.

Regarding the pension reform, Datafolha released a survey showing the support for the proposal currently in Congress among the population. About half of the citizens (51%) are against the current reform, but this number represents a 20 p.p. decrease since the last survey (in 2017), which asked about the previous government’s proposal. The percentage of people in favor of the reform increased to 41%, from 23%. The number of indifferent citizens remained stable (2%), while the group that doesn’t know increased to 7% (from 5%).


According the results of the central bank’s monthly analyst survey, one fewer rate hike is expected in the medium-term as growth continues to be revised down and inflationary pressures seem contained. Analysts continue to see only one more 25bp hike this year, to 3.25%, in 4Q19. The policy rate is still seen stable at 3.25% during the first few months of 2020, with another hike to 3.5% during mid-year. However, no further rate hikes are now expected (3.75% previously), which could in part reflect market expectations that the central bank would lower its estimate of the neutral rate (from the current 4%-4.5% range) in its June Inflation Report. Despite inflation surprising to the upside in March, forecasts were unchanged: 2.7% for this year (Itaú: 2.6%), and 3% for 2020 (also the 23-month expectation). Hence, the market continues to see the low annual inflation as a transitory occurrence. The growth forecast for this year was lowered for the third consecutive month by 0.1pp, to 3.3% (Itaú: 3.2%), while remained unchanged at 3.4% for 2020. We believe that weaker activity momentum at the beginning of the year, low inflation, the looser policy stance by the Fed and risks to global economic growth suggest there is no need to remove stimulus rapidly in the near term.

Car sales dropped in 1Q19. The National Automotive Association of Chile (ANAC) reported that car sales decreased 9.5% yoy in March, continuing the trend registered in February (-5.1%). Hence, in the first quarter of the year, sales fell 3.5%, down from the 6.3% expansion in 4Q18. At the margin, car sales dropped 2.8% (seasonally adjusted) from February, resulting in an 11.8% qoq/saar fall. The moderation of car sales in 1Q19, along with weak retail sales indicators, could be a sign of weakening consumption. However, still low inflation, an expansionary monetary policy and a broadly stable exchange rates are likely to support consumption ahead. We expect growth of 3.2% this year (4% last year).


Core inflation remained stable at low levels in March. According to the Central Bank, the average of core inflation measures came in at 2.82% in March, similar to February, which was the lowest level since October 2014. Overall, tradable goods inflation (excluding food and regulated items) was broadly stable below 1%, remaining the key drag to headline inflation (3.21% in March). Non-tradable inflation (also excluding food and regulated prices) continues to edge closer to the central bank’s target, reaching 3.29%. Meanwhile, the regulated component pulled-up inflation in the month, gaining 6.42% yoy (5.72% previously). We expect inflation to end the year at the central bank’s 3.0% target (3.18% in 2018), as the negative output gap and controlled inflation expectations would keep inflation at bay. With sluggish activity and subdued inflation pressures, we expect the central bank to keep the policy rate stable at 4.25% for the time being (next decision meeting: April 26).


Tomorrow’s Agenda: The Statistics Institute (INEGI) will publish the February industrial production data at 10:00 AM. We estimate a decrease of 0.8% yoy, from -0.9% in January. At 11:00 AM, the central bank will publish the minutes of the March’s monetary policy meeting, when Board members voted unanimously to leave the policy rate unchanged at 8.25%.


Tomorrow’s Agenda: At 8:00 PM, the central bank will publish its April’s reference rate decision, which we expect to remain unchanged at 2.75%.


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