World’s Most Hawkish Central Banker Is Losing Inflation War
No central banker in the world is taking on inflation this year like Roberto Campos Neto.
In March, the head of Brazil’s central bank shocked traders in Sao Paulo with a bigger-than-expected interest rate hike -- 75 basis points. It was a classic central banking gambit, executed by the grandson of one of Brazil’s pre-eminent economic minds: Unleash a great show of force from the outset to prove you’re a true inflation fighter, and you’ll quickly drive down investors’ inflation expectations and possibly ease the need for additional hikes.
For good measure, Campos Neto and the bank board raised another 75 basis points in May, and by their own indications they’ll do the same again at Wednesday’s policy meeting in Brasilia, taking the benchmark Selic to 4.25%.
And yet, his bold plan does not appear to be working.
A key bond-market measure of inflation expectations has barely budged since that first rate hike back in March. What’s more, inflation forecasts in the central bank’s weekly survey of economists have gone up, not down, over that time. Just on Monday, they lifted their estimates for this year and the next to 5.82% and 3.78%, respectively, both above target. Much of this, in fairness, is explained by things out of Campos Neto’s control: a large budget deficit, soaring global commodity prices and a severe drought that is driving up electricity bills.
All these elements are conspiring against the central bank and, in the process, raising a crucial question: Is the 51-year-old former trader ready to signal the bank will get even more aggressive with rate hikes -- even though that may undermine the economy’s recovery from its Covid collapse -- or will he balk and risk letting inflation take off?
“What I hope they understand,” said Tony Volpon, a former Brazilian central bank director, “is that what they are doing is not working. It’s not stopping expectations. You have to do something different.”
Transparency and Credibility
Inflation expectations for 2022, in particular, aren’t responding to the aggressive rate hikes because many economists disagree with the central bank’s indication that it won’t need to withdraw all of its monetary stimulus to control inflation, and that just moving fast with the tightening cycle will do the trick.
Pressed on that issue, Campos Neto said last week that the so-called “partial normalization” of monetary policy -- which means keeping a certain level of stimulus in place -- isn’t a blind promise by the central bank but an effort at transparency. He added that the bank’s decisions are data-driven and, most importantly, that it remains 100% committed to the inflation target, which stands at 3.5% for 2022. The bank declined to comment further when contacted for this story.
That’s why most economists are now expecting that Campos Neto, to make good on that promise, will remove any indication of future rate actions from the bank’s communications and opt for a simpler approach, saying only that policy makers will do the necessary to rein in prices.
“No one can criticize transparency, but it will also add volatility in the short-term,” said David Beker, head of Brazil for Bank of America Securities Inc. “It’s like they are doing two meetings in one.”
What Bloomberg Economics Say
“We expect the Brazilian central bank to deliver on the plan outlined in its last meeting, bringing the Selic to its pre-pandemic level by raising it to 4.25% on Wednesday. Most attention, however, will be on the post-meeting statement. We expect policy makers to adopt a more hawkish tone, without necessarily committing to full normalization in the coming months.”
-- Adriana Dupita, Brazil economist
Brazil’s outlook remains more complex than usual during the pandemic, with an economy that needs a faster vaccination pace to fully reopen. Potentially easing inflation pressures is a recent strengthening of the real, which turned the corner from the worst-performing Latin American currency last year to the second best in 2021. But at the same time a drought and faster-than-expected economic activity are pushing services prices up.
By Wednesday, the Brazilian central bank will likely have increased its benchmark rate by 225 basis points, and an additional 200 basis points are in the pipeline this year, according to economists. Among major central banks, only Turkey’s has increased rates so aggressively -- by 875 basis points in 2020 and 200 basis points this year, but policy makers there are already considering when to cut them.
Volpon, currently an investment strategist at Wealth High Governance, said Brazil’s central bank is probably “just not ready for a dot plot guidance,” or the detailed interest-rate forecasts from board members that the U.S. Federal Reserve usually provides.
When Campos Neto delivered his shocking rate hike accompanied by the “partial normalization” pledge, traders priced in what the bank had indicated for only 48 hours, before starting to bet on future hikes of as much as 100 basis points.
Volpon and most economists consulted for this story agree that the message needs to be simpler: just say you’ll do whatever it takes to fight inflation.
“Forward guidance in Brazil can be too tricky,” said Alejandro Cuadrado, Latin America strategist for BBVA in New York. “Brazil, along with the rest of emerging markets, remains too focused on the short term.”