Brazil's inflation data for January has created significant uncertainty regarding the medium-term inflation trajectory. Under several assumptions, using a structural inflation model, there is a possibility of grim inflation outlook. Actually, Brazilian inflation is not seen moderating to the central bank's target range by the end of 2017 under any assumption except for a sharp appreciation of the Brazilian real. However, the sharp appreciation is very much unlikely due to the fiscal situation that leaves the central bank policymakers with the only option of raising the Selic target rate if the external demand and commodity prices do not improve. This increases the upside risk of further tightening.
Brazil's inflation accelerated to 10.71% y/y in January, as compared with December's 10.67% y/y. It was more than the market forecasts and disproved the view that the base impact alone will be enough to help moderate inflation in 2016. This year, food inflation is expected to be the main challenge. In January, food inflation accelerated to 12.9% y/y, the strongest since May 2013. A combination of factors has resulted in the acceleration of food inflation and is not expected to begin moderating before Q2 2016 given the base effect.
There is an increasing likelihood that inflation will moderate in 2016 much lesser than SG's forecast of 7.2%. The structural inflation model indicates that inflation might be much higher than projected until recently.
