Inflation Outlook

Quarterly Inflation Report

Carlos Viana de Carvalho

December 2017

1

2

Índice

I. Introduction

II. Baseline Scenario

i. Economic Activity

ii. External Scenario

iii.Inflation

III. Conditional Forecasts

3

I. Introduction

4

Banco Central do Brasil – Institutional Mission

• To ensure the stability of the currency's purchasing power and a solid and efficient

financial system;

• The mission to ensure price stability is accomplished through the inflation targeting

regime, in which the targets are defined by the National Monetary Council (CMN).

Introduction

5

Basic Principles

• Low, stable and predictable inflation: best contribution of monetary policy forsustainable growth;

• High and volatile inflation:

• generates distortions, increases risks, shortens planning horizons, depresses

investment and economic growth;

• regressive;

• in short, reduces potential growth, affects employment and income generation,

worsens income distribution.

Introduction

6

II. Baseline Scenario

7

i. Economic Activity: • signals compatible with gradual recovery of the Brazilian economy;• high level of economic slack.

ii. External Scenario: • global outlook has been favorable;• global economic activity remains on a recovery path, without pressuring financial conditions in

advanced economies;• this supports risk appetite towards emerging economies.

iii. Inflation: • favorable development; underlying inflation measures running at low or comfortable levels;• expectations for 2017, 2018, 2019 and 2020 around 2.8%, 4.0%, 4.25% and 4.0%, respectively.

8

i. Economic Activity

9

Broad Retail SalesEconomic Activity

Source: IBGE

2014

=100

, s. a

.

87.08

80

85

90

95

100

105

oct 1

3

feb

14

jun

14

oct 1

4

feb

15

jun

15

oct 1

5

feb

16

jun

16

oct 1

6

feb

17

jun1

7

oct 1

7

10

Industrial ProductionEconomic Activity

Souce: IBGE

2014

=100

, s.a

.

82

87

92

97

102

107

oct 1

3

feb

14

jun

14

oct 1

4

feb

15

jun

15

oct 1

5

feb

16

jun

16

oct 1

6

feb

17

jun

17

oct 1

7

87.587

92

97

102

oct 1

3

feb

14

jun

14

oct 1

4

feb

15

jun

15

oct 1

5

feb

16

jun

16

oct 1

6

feb

17

jun

17

oct 1

7

11

Services sector revenuesEconomic Activity

Source: IBGE

2014

=100

, s.a

.

12

IBC-BrEconomic Activity

Source: BCB

2002

=100

, s.a

.

132

134

136

138

140

142

144

146

148

150

oct 1

3

feb

14

jun

14

oct 1

4

feb

15

jun

15

oct 1

5

feb

16

jun

16

oct 1

6

feb

17

jun

17

oct 1

7

MM3mmonthly

Month: 0.29% (s.a.)Quarter: 0.31% (s.a.)(Q/Q4): 1.72%

13

Market Expectations for GDPEconomic Activity

Source: BCB

grow

th%

até 12/15

0.94

2.00

2.64

0.20.40.60.81.01.21.41.61.82.02.22.42.62.8

Oct

16

Nov

16

Dec

16

Jan

17

Feb

17

Mar

17

Apr 1

7

May

17

Jun

17

Jul 1

7

Aug

17

Sep

17

Oct

17

Nov

17

Dec

17

2017

2018

14

Agents’ Confidence - BusinessmenEconomic Activity

Souce: FGV Obs.: proportion of favorable answers – proportion of unfavorable answers + 100

3mm

a, s.

a.

3mm

a, s.

a.

60

70

80

90

100

Mar

14

Jul 1

4

Nov

14

Mar

15

Jul 1

5

Nov

15

Mar

16

Jul 1

6

Nov

16

Mar

17

Jul 1

7

Nov

17

servicesindustry 65

75

85

95

105

Mar

14

Jul 1

4

Nov

14

Mar

15

Jul 1

5

Nov

15

Mar

16

Jul 1

6

Nov

16

Mar

17

Jul 1

7

Nov

17

constructioncommerce

15

Installed Capacity Utilization Level (NUCI)Economic Activity

Source: FGV

%, s

.a.

74.2

72

73

74

75

76

77

78

79

80

81

82

Jul 1

4

Nov

14

Mar

15

Jul 1

5

Nov

15

Mar

16

Jul 1

6

Nov

16

Mar

17

Jul 1

7

Nov

17

16

Labor MarketEconomic Activity

Source: IBGE (PNADC)

m/m

-3 c

hang

e(%

) s.a

.

Population Unemployment

%

0.7

0.5

-1.2

-0.8

-0.4

0.0

0.4

0.8

1.2

Oct

14

Feb

15

Jun

15

Oct

15

Feb

16

Jun

16

Oct

16

Feb

17

Jun

17

Oct

17

OP labor force (OLF)

12.2

6

7

8

9

10

11

12

13

14

Oct

14

Feb

15

Jun

15

Oct

15

Feb

16

Jun

16

Oct

16

Feb

17

Jun

17

Oct

17

17

Box: 2017 and 2018 GDP Projections

• Growth of 1.0% in 2017 and 2.6% in 2018.

Supply:

• agriculture and livestock: 12.8% in 2017 and -0.4% in 2018 (-4.3% in 2016);

• industry: -0.3% in 2017 and 2.9% in 2018 (-4.0% in 2016);

• services: 0.3% in 2017 and 2.4% in 2018 (-2.6% in 2016).

Demand:

• investment: -2.5% in 2017 and 3.0% in 2018 (-10.3% in 2016);

• household consumption: 1.2% in 2017 and 3.0% in 2018 (-4.3% in 2016);

• government consumption : -0.8% in 2017 and 1.0% in 2018 (-0.1% in 2016);

• net exports: 0.1 % in 2017 and -0.2% in 2018 (1.7 % in 2016).

Boxe

18

Box: Industry growth analysis – 2017• Analysis of the characteristics of the industry recently:

• internal demand was the main growth sector during 2017;• marginal better growth dispersion;• growth driven by more cyclical industry sectors.

Boxe

(p.p

.)

3-month decomposition of the accumulatedchange of the PIM-IG

2012

=100

s.a

.

PIM-IG and group as correlated with general industry

-8

-6

-4

-2

0

2

4

Oct/15 Feb/16 Jun/16 Oct/16 Feb/17 Jun/17 Oct/17

Internal Demand Exports coeficient

Imports penetration PIM-IG

60

80

100

120

Oct/07 Oct/09 Oct/11 Oct/13 Oct/15 Oct/17Low Medium High correlation PIM IG

19

Box: Transition rate and recent evolution in labour market• Analyzes recent evolution of transition rates on unemployment:

• recent decline in the unemployment rate explained mainly by the improvement in transition ratesbetween: (1) employed and unemployed; (2) unemployed and out of the labor force; (3) unemployedand formal jobs and (4) out of the labor force and self-employed;

• however, transition rates are still at levels worse than those observed over longer periods, requiringadditional improvements to allow for sharper declines in the unemployment rate.

Boxe

(p.p

.)

Effect on transition rate changes onunemployment rate

(%)

Unemployment rateProspective scenarios

10.8

11.2

11.6

12.0

12.4

12.8

Mar

17

Jun

17

Sep

17

Dec

17

Mar

18

Jun

18

Sep

18

Dec

18

Mar

19

Jun

19

Sep

19

Dec

19

Fixed transition rateEvolving transition rate (last year pace)

-0.15

-0.10

-0.05

0.00

0.05

UP

and

SE

UP

and

PNLF

UP

and

CC W

orke

rs

PNLF

and

SE

UP

and

Publ

ic

PNLF

and

Pub

lic

UP

and

SC W

orke

rs

PNLF

and

SC

Wor

kers

PNLF

and

Oth

ers

PNLF

and

Em

ploy

ed

UP

and

Empl

oyer

s

NW

AP a

nd U

P

UP

and

Oth

ers

PNLF

and

CC

Wor

kers

20

Box: Recent credit evolution in the corporate segment• Analyzes credit performance for corporations in recent years:

• persistent retraction in the total balance since mid-2016;• credit evolution in this segment is conditioned by operations for companies with large financial capacity;• increased concentration in a small group of companies;• on the credit supply side the majority of operations is from financial institutions under public control.

Boxe

(%)

Credit operations total balance

R$ b

illio

n

Balance by debt range

-12

-8

-4

0

4

8

12

16

Oct2014

Apr2015

Oct Apr2016

Oct Apr2017

Oct

Non-financial corporations Households

900

1.000

1.100

1.200

1.300

0

50

100

150

200

250

300

Dec2014

Jun2015

Dec Jun2016

Dec Oct2017

Between R$20 millions and R$50 millionsGreater than R$1 million and less than R$20 millionsLess than R$1 millionGreater than R$50 millions (right axis)

21

Box: Recente credit evolution at the legal entities segment

• Capital market:• growth of 54% in funding from the capital market accumulated until October 2017;• values in Brazilian reais higher than those observed in the pre-crisis period (2014);• in the first ten months of the year, domestic domestic issuance grew 75% while foreign issuance grew 29%;• the reduction of bank credit to LE is being offset by a greater capital market dynamism.

Boxe

900

1 100

1 300

1 500

1 700

2012 2013 2014 2015 2016 2017

SFN

SFN + Captações no mercadode capitais

0

50

100

150

200

250

300

2012 2013 2014 2015 2016 2017

Emissão doméstica

Emissão externa

R$ b

illio

n

Raising at capital market(acummulated up to October)

R$ b

illio

n

Raising at NFS and at capital market(acummulated up to October)

22

Box: Projections for 2017 and 2018 BoP

• Current account deficit of US$9.2 billion (0.45% of GDP) in 2017 and of US$18.4 billion (0.88% of GDP) in2018:

• trade balance: US$64 billion in 2017 and US$59 billion in 2018;• net interest expense: US$21.3 billion in 2017 and US$16.9 billion in 2018;• profits and dividends expense: US$21.5 billion in 2017 and US$25.5 billion in 2018.

• FDI net inflow of US$75 billion in 2017 and of US$80 billion in 2018, smoothly funding the current account.

• Rollover rate at 100% in 2017 and 2018.

Boxe

23

Box: Direct investment statistics by immediate and ultimate investing country• Immediate and ultimate investor country concepts and the statistics of the Brazilian case are presented:

• both concepts are presented follwing the international statistics standard;• the globalization and complexity of the organizational structures of transnational corporations

increases the relevance of these statistics, which have been complementary;• as regards to Brazil, there is a substantial change in the stock of each country according to the

concept used.

Boxe

Highest increases in FDI stocks – capital shareImmediate and ultimate investing countryOn 12.31.2015

Highest decreases in FDI stocks – capital shareImmediate and ultimate investing countryOn 12.31.2015

Country Immediate Ultimate Difference

US$ million

United States 69.048 77.046 7.998

China 1.366 8.606 7.240

Italy 4.258 10.824 6.566

United Kingdon 15.549 21.894 6.345

Germany 8.323 12.472 4.149

Switzerland 11.063 14.761 3.698

France 18.437 21.309 2.872

Canada 7.574 9.791 2.217

Bermuda 2.626 4.714 2.089

Japan 17.110 18.914 1.804

Country Immediate Ultimate Difference

US$ million

Netherlands 90.332 51.353 -38.979

Luxembourg 27.063 10.977 -16.086

Belgium 3.607 935 -2.672

Chile 7.200 5.363 -1.836

Spain 39.044 37.472 -1.572

Sweden 3.049 1.673 -1.375

Uruguay 2.436 1.432 -1.005

British Virgin Islands 2.304 1.501 -803

Cayman Islands 2.978 2.181 -797

Ireland 1.614 842 -772

24

ii. External scenario

Prospects of Moderate Global GrowthExternal Scenario

25

GDP

annu

algr

owth

-%

3.7

3.6

3.0

3.1

3.2

3.3

3.4

3.5

3.6

3.7

3.8

Dec

15

Feb

16

Apr 1

6

Jun

16

Aug

16

Oct

16

Dec

16

Feb

17

Apr 1

7

Jun

17

Aug

17

Oct

17

Dec

17

201720182019

Source: Bloomberg (12/15)

Activity – GDP Annual GrowthExternal Scenario

26

2017/2018/2019: projection

%%

%

2.282.52

2.14

1.0

1.5

2.0

2.5

3.0

2012

2013

2014

2015

2016

2017

2018

2019

%

United States

China

Euro Area

Japan

6.80

6.40 6.20

5.8

6.3

6.8

7.3

7.8

2012

2013

2014

2015

2016

2017

2018

2019

1.601.30

1.00

-0.5

0.0

0.5

1.0

1.5

2.0

2012

2013

2014

2015

2016

2017

2018

2019

2.30

2.051.70

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2012

2013

2014

2015

2016

2017

2018

2019

Source: Bloomberg (12/15)

InflationExternal Scenario

27

%%

%

2.102.13

2.20

0.5

1.0

1.5

2.0

2.5

2012

2013

2014

2015

2016

2017

2018

2019

%

United States

China

Euro Area

Japan

1.60

2.302.20

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2012

2013

2014

2015

2016

2017

2018

2019

0.450.80 1.00

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2012

2013

2014

2015

2016

2017

2018

2019

1.50 1.50 1.60

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2012

2013

2014

2015

2016

2017

2018

2019

Source: Bloomberg (12/15) 2017/2018/2019: projection

Long-term interest rateExternal Scenario

28

% a

.a.

10 years

Source: Bloomberg (15/12)

2.354

0.299

0.046

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Oct

15

Dec

15

Feb

16

Apr 1

6

Jun

16

Aug

16

Oct

16

Dec

16

Feb

17

Apr 1

7

Jun

17

Aug

17

Oct

17

Dec

17

USAEuro AreaJapan

Commodities pricesExternal Scenario

29

inde

x (1

967=

100)

CRB Index

338,2

430,4

508,4

886,0

inde

x (1

967=

100)

Source: Bloomberg (15/12)

500

550

600

650

700

750

800

850

900

950

300

360

420

480

540

Oct

15

Dec

15

Feb

16

Apr 1

6

Jun

16

Aug

16

Oct

16

Dec

16

Feb

17

Apr 1

7

Jun

17

Aug

17

Oct

17

Dec

17

CRB (left)food (left)raw materials (left)metals (right)

Favorable scenario to emerging countries

Source: Bloomberg (15/12)

30

External Scenario

basis

poin

ts

5 years sovereign CDS

50

100

150

200

250

300

Dec

16

Feb

17

Apr 1

7

Jun

17

Aug

17

Oct

17

Dec

17

Mexico Turkey South Africa Russia Brazil

31

iii. Inflation

32

Monthly IPCA – Expectations x ProjectedInflation

Sources: IBGE and BCB

diffe

renc

e be

twee

n oc

curr

ed a

nd p

roje

cted

* (p

.p.)

-0.30

-0.20

-0.10

0.00

0.10

0.20

0.30

Jul 1

5

Sep

15

Nov

15

Jan

16

Mar

16

May

16

Jul 1

6

Sep

16

Nov

16

Jan

17

Mar

17

May

17

Jul 1

7

Sep

17

Nov

17

occurred IPCA > projected IPCA

occurred IPCA < projected IPCA

* projected on the IPCA Top 5 reference dates

33

Food DisinflationInflation

Sources: IBGE, FGV and BCB

% p

.m.

shadowed area: highs and lows for each month of 2007-2014

% p

.m.

IPCA - Food

IPA – Total (10, M and DI – chained)

-4.5-3.0-1.50.01.53.04.56.0

Nov

15

Dec

15Ja

n 16

Feb

16M

ar 1

6Ap

r 16

May

16

Jun

16Ju

l 16

Aug

16Se

p 16

Oct

16

Nov

16

Dec

16Ja

n 17

Feb

17M

ar 1

7Ap

r 17

May

17

Jun

17Ju

l 17

Aug

17Se

p 17

Oct

17

Nov

17

Agricultural and livestock prod. (25.6%)Industriais products (74.4%)IPA

-2

-1

0

1

2

3Ja

n

Feb

Mar Ap

r

May Jun Jul

Aug

Sep

Oct

Nov De

c

2007-14 range 2016 2017

34

Underlying inflation measuresInflation

Sources: IBGE, FGV and BCB

% p

.m.

0.21

0.0

0.2

0.4

0.6

0.8

1.0

jan

feb

mar ap

r

may jun jul

aug

sep

oct

nov

dec

Seasonal range (3.0% - 6.0%)20162017

Shadowed area: seasonal pattern compatible with target interval

EX1 Core*

* Exclusion of 10 of the 16 items in the At-home Food group and household fuels and vehicle fuels..

% p

.m.

0.130.0

0.2

0.4

0.6

0.8

1.0

jan

feb

mar ap

r

may jun jul

aug

sep

oct

nov

dec

Seasonal range (3.0% - 6.0%)20162017

Trimmed Average Core

2

3

4

5

6

7

8

9

10

11

2012

2013

2014

2015

2016

2017

2018

2019

IPCAFocus

35

Consumers priceInflation

Source: BCB

target (4.5%)

Nov 172.80%

% in

12

mon

ths

Focus: expectations in 12/15

36

Evolution of 2017-2021IPCA Market ExpectationsInflation

Source: BCB (15/12)

%

4.00

2.83

4.25

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

Dec

15

Feb

16

Apr 1

6

Jun

16

Aug

16

Oct

16

Dec

16

Feb

17

Apr 1

7

Jun

17

Aug

17

Oct

17

Dec

17

20172018201920202021

0

2

4

6

8

10

12

14

16

18

Jan

11

Jul 1

1

Jan

12

Jul 1

2

Jan

13

Jul 1

3

Jan

14

Jul 1

4

Jan

15

Jul 1

5

Jan

16

Jul 1

6

Jan

17

Dec

17

Dec

18

administered pricesmarket prices

37

Market and Administered PricesInflation

Sources: IBGE and BCB

% in

12

mon

ths

*Expectations on 12/15

IPCA Administered (%)2015 18.072016 5.50expectations 2017* 7.90

2018* 4.90

IPCA Market (%)2015 8.512016 6.54expectations 2017* 2.83

2018* 4.00

2.8*

7.9*

4.0*4.9*

38

Box: Brazil Commodities Index (IC-Br) – Methodological Revision

• Considering the relevance of commodity prices for inflationary cycles in Brazil, this boxupdates the calculation approach of the IC-Br, aiming to adapt the index to structuralchanges observed in the Brazilian economy and to maximize its correlation with the IPCA.

Inflation

2

4

6

8

10

12

14

16

18

-20

0

20

40

60

80

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

% in 12 months

IC-Br (MM3)

IPCA

0.520.530.540.550.560.570.580.590.600.610.62

Benchmark CRB IMF IC-Br"previous"

IC-Br

R2 adjusted to different indexes

39

III. Conditional Forecasts

% change

2017 2018

Dec Jan Feb In thequarter

12 months to

Feb

Copom scenario1/ 0.29 0.53 0.47 1.30 3.091/ Scenario at the cutting date

% change

2017

Sept Oct Nov in thequarter2/

12 monthsto Nov

Copom Scenario1/ 0.17 0.46 0.40 1.04 2.98

Observed IPCA 0.16 0.42 0.28 0.86 2.80

Surprise (p.p) -0.01 -0.04 -0.12 -0.18 -0.181/ Scenario at the September 2017 Inflation Report cutting date2/ Differences between monthly and accumulated values due to rounding

40

Revisions and Short-Term ForecastsCondicional Forecasts

Sources: IBGE and BCB

IPCA – Short-Term Forecasts

IPCA – Inflationary Surprise

41

Conditional Inflation ForecastsCondicional Forecasts

Source: BCB

Scenario with Focus Selic and Exchange Rates

Period September RI December RI

2017 4 3.2 2.82018 1 3.6 3.22018 2 4.3 3.72018 3 4.3 3.82018 4 4.3 4.22019 1 4.3 4.22019 2 4.2 4.22019 3 4.2 4.32019 4 4.2 4.22020 1 4.1 4.22020 2 4.1 4.22020 3 4.1 4.12020 4 4.1 4.1

Obs.: 4 quarters accumulated inflation (%)

42

Projeções Condicionais para a InflaçãoCondicional Forecasts

Source: BCB

% in

4 q

uart

ers

Focus Scenario with Selic and Exchange Rates

0

2

4

6

8

1T 1

7

2T 1

7

3T 1

7

4T 1

7

1T 1

8

2T 1

8

3T 1

8

4T 1

8

1T 1

9

2T 1

9

3T 1

9

4T 1

9

1T 2

0

2T 2

0

3T 2

0

4T 2

0

43

Conditional Inflation ForecastsCondicional Forecasts

Source: BCB

Reported Scenarios

Period

Focus Selic and

Exchange Rates

Focus Selic and

Constant Exchange

Rate

Constant Selic and Exchange

Rates

Focus Constant Selic and Exchange

Rate

2017 4 2.8 2.8 2.8 2.82018 1 3.2 3.2 3.2 3.22018 2 3.7 3.7 3.7 3.72018 3 3.8 3.7 3.7 3.72018 4 4.2 4.1 4.0 4.12019 1 4.2 4.0 4.0 4.12019 2 4.2 4.1 4.1 4.32019 3 4.3 4.1 4.2 4.42019 4 4.2 4.0 4.1 4.42020 1 4.2 4.0 4.2 4.42020 2 4.2 3.9 4.2 4.42020 3 4.1 3.8 4.1 4.32020 4 4.1 3.9 4.2 4.4

Obs.: 4 quarters accumulated inflation (%)

44

Conduct of Monetary Policy - 1

• In its meeting in December (211th meeting), the Copom unanimously decided forthe reduction of the basic interest rate by 0.5 percentage points, to 7.0percentage p.y., without bias.

• The Committee understands that convergence of inflation to the target over therelevant horizon for the conduct of monetary policy, which includes the calendar-years of 2018 and 2019, is consistent with the monetary easing process.

• On that occasion, the Committee reported that its baseline scenario involves riskfactors in both directions:

• On the one hand, possible second-round effects of the favorable food priceshock and of low industrial goods inflation, and the possible propagationthrough inertial mechanisms of the low level of current inflation;

• On the other hand, frustration of expectations regarding the reforms and areversal of the current benign global outlook for emerging economies.

45

Conduct of Monetary Policy - 2

• The Copom judges that the economic conditions prescribeaccommodative monetary policy, i.e., interest rates below the structurallevel.

• The Committee emphasizes that the process of reforms and necessaryadjustments in the Brazilian economy contributes to the reduction of itsstructural interest rate. Estimates of this rate will be reassessed overtime.

46

Conduct of Monetary Policy - 3

• The Copom highlights that the evolution of the baseline scenario, in line withexpectations, and the stage of the monetary easing cycle made it appropriate toreduce the Selic rate by 0.5 percentage point at its December meeting. Regardingthe next meeting, provided the Committee's baseline scenario evolves asexpected, and taking into account the stage of the monetary easing cycle, at thistime the Copom views an additional moderate reduction of the pace of easing asappropriate. The Committee views this guidance as more susceptible to changesin its baseline scenario and balance of risks than in the previous meetings. Goingforward, the Committee judges that the current stage of the cycle recommendscaution in conducting monetary policy. The Copom emphasizes that the monetaryeasing process will continue to depend on the evolution of economic activity, thebalance of risks, possible reassessments of the extension of the cycle, and oninflation projections and expectations.

Inflation expectations

Quarterly Inflation Report

Carlos Viana de Carvalho

December 2017

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