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Lula’s attack on the Central Bank worries operators in Brazil

So when President Luiz Inácio Lula da Silva, only three weeks in office, questioned the need for an autonomous central bank during an interview on national television last week, it did not go over well with the markets. Swap rates soared and the currency plunged after his remarks. Cabinet members came on the scene and managed to stem the slide earlier that day, but the episode left many investors increasingly alarmed by a Lula presidency they are finding very different from the one that oversaw an economic boom in previous years.

Lula has filled his economic team with loyalists to the left, has lashed out at fiscal rules and now, with his thinly veiled attack on central bank autonomy, has taken a stance that casts doubt on the government’s commitment to stem the rise in consumer prices in a country with a long history of nasty bouts of inflation. Lula’s saber rattling, and that of his aides in previous days, stems largely from frustrationinvestors say because of the growing clash between his fiscal policy, aimed at boosting an economy in crisis, and the central bank’s high interest rate policy, aimed at bringing inflation down to target.

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The consequences in the financial markets have not been long in coming. Since Lula’s election on October 30, the Brazilian real has underperformed most of its developing country counterparts. The index MSCI Brazil it has fallen 2% over the same period, contrasting with a 23% rise in its emerging markets benchmark.

“The size and speed of changes in Brazil’s economic framework have surprised us”said Gustavo Pessoafounding partner of the hedge fund manager Legacy Capital in Sao Paulo. “The formal autonomy of the central bank is a strong legacy left by the previous Administration and will probably prevail, but it has been tested and attacked on a daily basis.”

Brazil disengages

Investors were increasingly wary of possible failures in the relationship with the monetary authority, even before Lula’s sharp comments on television. Your Minister of Tax authorities, Fernando Haddad, he had hinted at the tensions, underscoring how monetary policy can hurt government revenue, the basis of his plans to reduce the fiscal gap, and signaling his discomfort with warnings from the central bank that additional government spending would fuel inflation.

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The increase in consumer prices was the most moderate among the emerging economies last year, but economists have warned that structural changes such as the promotion of subsidized credit or the reversal of the labor reform, both proclaimed by some members of the Government of Lula, you can change the situation.

The head of the central bank himself, Roberto Campos Neto, has repeatedly addressed these concerns, stating that such moves could “reduce the power” of monetary policy and reinforcing that policymakers “will not hesitate” to raise interest rates if necessary.

Concern about the path of fiscal policy and its impact on inflation has been one of the main reasons why investors have been avoiding local assets. Capital View He had singled out an attack on central bank autonomy as a “significant risk” underestimated by markets in a note late last year, but the topic became ubiquitous after the interview, and money managers now expect the administration to force a change in Brazil’s inflation targets.

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The government is expected to set the 2026 target in June and could revise the current 3% target for 2024 and 2025.

“Lula’s decision to publicly declare twice that the inflation target should be higher did not go unnoticed, and may further reinforce the rise in long-term inflation expectations,” wrote in a note Cassiana Fernandezeconomist of JPMorgan & Chase Co.

Analysts surveyed have raised inflation estimates for 2023 six weeks in a row, and also expect consumer prices to rise above target through 2025.

What Bloomberg Economics Says

“We have no reason to believe that Lula will attempt to improperly influence monetary policy. Whether that perception endures depends on three missing pieces of the puzzle. First, if Lula and Haddad will apply a good and credible fiscal rule. Second, whether the government will provide cheap financing for state banks to provide subsidized loans. Finally, if Lula will push for a higher inflation target for the next few years. These issues are much more important than any public bullshit by Lula or Haddad and the central bank,” he said. Adriana Dupitaeconomist of Bloomberg for Brazil.

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Source: Gestion

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