Could higher inflation push Brazil’s central bank to pull the rate trigger?

Inflation in Brazil is accelerating and the question is whether the central bank will react by pulling the rate hike trigger. 

The country's IPCA inflation index increased to 4.50% in the 12 months through July, up from 4.23% in the previous 12-month period, according to statistics bureau IBGE.

The monetary authority's inflation target for this year is 3%, with a tolerance range of 1.50-4.50%.

The market’s 2024 inflation forecast rose to 4.20% from 4.12% a week earlier, according to a weekly central bank survey with 100 economists published on Mondays. 

"What is generating pressure at the moment is inflation in the services sector. This inflation produces pressure whenever we have a tight labor market, which is the case in the current scenario," Luciano Rostagno, chief strategist at EPS Investimentos, told BNamericas.

"Services inflation is beginning to show that it may impact the inflation of goods, and we also have to evaluate how the Brazilian real will perform versus the US dollar. If we see a depreciation of the local currency in the coming months, which would potentially generate more inflationary pressure, it is possible to see the central bank hiking interest rates this year although this is not the base case scenario," said Rostagno.

At the end of July, the central bank’s monetary policy committee (Copom) kept the Selic benchmark rate unchanged at 10.5% and said it does not rule out rate hikes if price pressures continue.

Due to inflation and fiscal concerns Copom ended its latest monetary easing cycle in May, which it began in August 2023 with the Selic at 13.75%. 

Another risk factor has also emerged as rain levels have been below average in recent months, impacting hydroelectric power generation, which makes up a major part of the country's energy matrix. This has forced the government to ask large industries to reduce their energy consumption in a bid to avoid using higher-cost thermoelectric plants. 

"The use of thermal plants, if necessary, automatically increases the final price of energy, which mainly impacts big industries," Janaina Donas, president of Brazilian aluminum association ABAL, told BNamericas.