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Lula da Silva's Central Bank Appointees Pivot Brazil Towards Growth-Oriented Policy

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Robert Tavares

May 7, 2024 - 09:19 am

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Lula's Influence Marks a New Era for Brazil's Central Bank

Brazil Central Bank

(Bloomberg) -- President Luiz Inacio Lula da Silva, having served 17 months into his term, has significantly influenced the Central Bank of Brazil, an institution he has frequently clashed with during his tenure. The composition of the bank's leadership has seen a shift with four out of the nine board members now being appointees of President Lula. These new members have gradually begun to alter the bank's focus, transitioning from a rigorously anti-inflationary stance to one that also values economic growth.

In various private meetings, the new appointees have emphasized the importance of bolstering economic growth, particularly now as inflation seems to be softening. Even so, the forecast for future price increases is still approximately 1 percentage point above the nation’s 3% target.

This subtle yet significant change indicates a preference within the Central Bank to adopt what may be considered a "behind the curve" approach. Such an attitude suggests a continuous trajectory of lowering interest rates and a hesitance to increase them immediately, should inflation rise again.

An Unclear Future Amid Fiscal and Global Uncertainties

These internal changes occur during a time of great uncertainty. Domestically, fiscal fluctuations and internationally, with the Federal Reserve’s hesitation to reduce its key rate, have led to debates among economists. Policymakers in Brazil are considering whether to decelerate the current easing cycle, which has seen the Selic benchmark interest rate lowered from a six-year peak to currently stand at 10.75%.

Market analysts have only recently adjusted the forecast for the end-of-year rate to 9.63%, reflecting uncertainties and the complex notion of a Central Bank that could potentially lag behind inflation trends.

The Rise of Picchetti and Shifts in Central Bank Policy

Much of the past year's market speculation revolved around whether Lula's nomination of Gabriel Galipolo, a former Finance Ministry official and probable successor to bank chief Roberto Campos Neto, would reshape the Central Bank. However, it has been Paulo Picchetti, Lula's pick for the bank's director of international affairs, who has become the most significant enigma since his board inclusion in January.

Picchetti, a renowned academic with a strong background in econometrics and also considered a possible successor to Campos Neto, has seldom spoken in public. However, in his inaugural interview with local media, he suggested that slowing the pace of interest rate cuts could lead to more favorable borrowing conditions by the end of this easing cycle.

Surprising investors at a private gathering in Washington last month, Picchetti displayed a greater concern for economic growth rather than inflation control, as reported by those present. He proposed that the Central Bank needs to diagnose reasons behind the worsened inflation forecasts, which have been consistently above target. Picchetti argued if the cause is fiscal, monetary policy alone would be ineffective in addressing it.

The Central Bank has not publicly commented on this shift in focus.

Sergio Werlang, a key figure in Brazil's 1990s inflation-targeting framework and an economist from Rio de Janeiro, interprets these changes in board composition as a move away from 'strict monetarism'. He anticipates that the current team will adopt a noticeably more dovish stance.

This does not indicate a reckless approach to rate cuts, according to Werlang. The nuanced modifications he foresees include tolerating inflation marginally above the target for the sake of ensuring economic growth.

Investor Anxieties Amid Erosion of Central Bank Credibility

Brazil's history with hyperinflation lends a particular gravity to these changes. Recent behavior by investors, who have bet that inflation will persist above the bank's objective until 2027, hints at a growing skepticism toward the policymakers’ commitment to reigning in price increases.

The credibility of the Brazilian Central Bank is at stake. Traditionalists within the institution have argued that a lack of firm commitment to inflation control could precipitate an accelerated increase in inflation. Diogo Guillen, the director of economic policy, has notably voiced concern over "unanchored" inflation forecasts during another private event in Washington, demonstrating an almost singular focus on this issue.

The Changing of the Guard and Economic Outlook

Campos Neto, who championed one of the most intense global easing responses to the pandemic followed by a tight tightening cycle during the economic reopening, continues to highlight concerns regarding growing global uncertainties and rising inflation. However, his presidency, which often finds itself at odds with Lula's Workers' Party, is due to conclude in December of this year.

Galipolo, one of Lula’s earliest appointees, has reiterated the need for "serenity" and "caution" in times of economic volatility. In his speeches, he has presented the view that staying slightly "behind the curve" could afford the bank a better understanding of market dynamics relative to inflation targets, a perspective aligning with Lula's preference for prioritizing economic growth.

In a positive turn of events, Brazil's yearly inflation rate has simmered to 3.77% as of mid-April, resting comfortably within the Central Bank’s margin of tolerance. Most projections remain optimistic, with expectations that inflation will stabilize around this level for the remainder of the year.

The concern among market participants over who will assume the presidency of the Central Bank looms large, according to Marcelo Kfoury, an economics professor and former Central Bank employee. Balancing the need to continue rate cuts with the courage to pause them is a dilemma now facing policymakers.

Lessons from the Past and Prospects for the Future

Brazil has not forgotten the consequences of lax monetary policies. Under the presidency of Dilma Rousseff about ten years ago, the Central Bank failed to respond effectively to rising prices, leading to a severe recession. Though not many anticipate a return to those tumultuous times, the Central Bank retains the capability to manage increasing inflation projections, provided they act judiciously.

While Lula has leveled criticism at the Bank's approach, as a political figure, he remains cognizant of inflation's harsh impact on Brazil's underprivileged populations. Carla Argenta, Chief Economist at CM Capital Markets, underscores the need for the Central Bank to regain its credibility to correct market misjudgments through clear and consistent communication.

In summation, Brazil's Central Bank stands at a crossroads. As it confronts shifting policy positions, the nation awaits the impact of a new monetary approach under Lula's growing influence. While increased transparency and commitment to maintaining inflation targets may assuage market concerns, the essence of Brazil's monetary future will be shaped by its capacity to balance growth with stability.

For further insights into how analysts are adjusting to the evolving outlook on Brazil's key rate forecast, refer to Brazil Analysts Move Toward Higher Year-End Key Rate Forecast.

As Brazil navigates these uncertain times, the dialogue between growth and stability remains focal. With expert assistance from Martha Beck, Bloomberg will continue to report on the unfolding developments and the strategic decisions marking Brazil's economic landscape in times to come.

©2024 Bloomberg L.P.