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| Tombini’s ability to keep prices in check will be tested |
Inflation-proof assets are increasingly favoured among investors in Brazil, suggesting market uneasiness about central bank chief Alexandre Tombini’s ability to keep prices in check while trying to revive Latin America’s largest economy.
Demand for inflation-protected bonds is on the rise, while shares of companies whose revenues grow in line with price indexes, such as water utility Sabesp or mall operator BRMalls, are hitting all-time highs.
Consumer inflation is traditionally faster in Brazil in the final four months of the year, when the end of the grains harvest pushes food prices higher and economic activity usually gathers speed.
This year, however, other factors are adding to the poor inflation outlook. They include a surge in commodity prices and an 11-month old central bank campaign for lower interest rates that has taken the benchmark Selic rate to an all-time low.
A series of economic stimulus measures launched by President Dilma Rousseff since the beginning of the year is also expected to finally bear fruit in the next few months, further stimulating domestic consumption.
“Inflation definitely is not going to keep going down,” said Claudio Irigoyen, Latin America fixed-income strategist with Bank of America Merrill Lynch. “We think this is going to become a problem down the road for the central bank to keep cutting rates because activity is going to be better in the second half of the year.”
Merrill Lynch currently recommends investors buy government bonds linked to the IPCA consumer price index. Brazil’s Treasury last tendered such securities, known as NTN-B, in an auction in late July, and all bonds offered were sold at prices higher than in previous sales.
Demand for NTN-B bonds increased even further after the IPCA index, which anchors the central bank’s inflation-targetting system, accelerated to a three-month high in June.
More importantly, 12-month inflation measured by the index rose to 5.20% from 4.92%, distancing from the center of Brazil’s inflation target for the first time since last October. The government currently targets inflation of 4.5%, with a tolerance margin that stretches from 2.5% to 6.5%.
While central bank chief Alexandre Tombini has said price spikes would be temporary, and that inflation would still converge to the center of that target in the next few months, many analysts are marking up their estimates for the IPCA this year to over 5%.
Merrill Lynch sees consumer inflation running at an annualized rate of 6% this month, while JP Morgan just revised up its estimate for the IPCA in 2012 to 5.2%.
The inflation spike brings a clear risk to the stock market, as it could eventually force the central bank to tighten monetary policy, reducing the allure of equities.
This time, however, policymakers seem to be more concerned about market forecasts that the economy could grow as little as 1.5% this year. Indeed, the vast majority of economists agree that Brazil’s interest rates will fall further in coming months - even as inflation creeps higher.
As part of Rousseff’s campaign for lower borrowing costs, the central bank has cut the benchmark Selic rate to 8% in July. Virtually all economists expect the rate to fall at least once more this month, to 7.5%. Some even bet it could reach 7.25% by October.
The combination of falling interest rates and rising inflation has proved to be a boon for some stocks.
Shares of Sabesp and BRMalls both reached all-time highs earlier this week, and their prospects remain favorable, analysts say.