Inflation Outlook

Luiz Awazu Pereira da Silva

Inflation Report September 24, 2015

2 2

I. Main Message

II. International Environment

III. Financial Conditions

IV. Activity

V. Inflation Developments

Index

3

I. Main Message (1)

The balance of risks has deteriorated, with recent elevations of the risk premmia, which reflect in the asset prices. The monetary policy strategy reaffirms the objective of the Central Bank to set inflation at 4.5% a.a. at the end of 2016, defining the necessary and sufficient conditions to reach it:

1. the maintenance of the current level of the Selic rate, for a sufficiently long period;

but, as it is not possible to be sure if the recent risk premia elevations are temporary or permanent,

2. this demands that the monetary policy, on the one hand, observe with attention the causes of volatility and, and on the other hand, keep vigilant in case of significant deviations of the Copom inflation projections from the target.

4

I. Main Message (2) In addition to our adjustment process (with its external, monetary and fiscal components), there is an ongoing series of non-economic events that affect the confidence and increase the markets’ volatility in Brazil

The recent communication of monetary authorities of advanced countries has not been sufficiently clear to guide the global markets and disperse uncertainties regarding the global growth; these uncertainties have increased the volatility in the assets prices of emerging countries in general, intensifying local negative perceptions in specific cases, as Brazil

In this context, it is necessary to have calm and analytic wisdom and to avoid excessive reaction; it is necessary to proceed with the announced policies, to separate the causes of volatility, to give direction to the market and to preserve its functionality

5

• Process of ongoing macroeconomic adjustment is standard, relevant and necessary; adjustment with three components (external, monetary and fiscal); and two phases (quantity, price)

• Adjustment is producing expected results in two components (external and monetary, e.g., improvement of the external accounts, strong disinflation in 2016, market expectations 9.3% 5.7% or around 360bps); but this needs to be consolidated in the fiscal component that is affecting the risk premia and might de-anchor inflation expectations

• We need to strengthen the economic policy and fundamentals; reinforce the preparation for the external normalization; and build a solid base for a new cycle of sustainable growth

First Results of the Adjustment in 2015

6 Source: BCB

Adjusting the Real Effective Exchange Rate (REER)

60

80

100

120

140

160

180A

ug 9

1

Au

g 9

3

Aug 9

5

Aug 9

7

Aug 9

9

Aug 0

1

Aug 0

3

Aug 0

5

Aug 0

7

Aug 0

9

Aug 1

1

Aug 1

3

Aug 1

5

Jun

94

=10

0

basket of 15 currencies

117.7

avg = 96.0

weaker REAL

stronger REAL

7 Source: The Economist

A Well Known Example: Big Mac Index U

S$

0

1

2

3

4

5

6

7

Ap

r 0

0

Ap

r 0

1

Ap

r 0

2

Ap

r 0

3

Ma

y 0

4

Ju

n 0

5

Ja

n 0

6

Ma

y 0

6

Ja

n 0

7

Ju

n 0

7

Ju

n 0

8

Ju

l 09

Ja

n 1

0

Ju

l 10

Ju

l 11

Ja

n 1

2

Ju

l 12

Ja

n 1

3

Ju

l 13

Ja

n 1

4

Ju

l 14

Ja

n 1

5

Ju

l 15

Brazil UK China US LA (-Brazil) Europe Russia

Price of Big Mac in US$ according to the current exchange rate

8 Source: BCB

External Sector Adjusting: Projection –US$65 bi in 2015

-103.6 -102.7 -102.4 -101.6

-99.3

-94.9

-92.5

-89.4

-84.5

-65.0

-105

-100

-95

-90

-85

-80

-75

-70

-65

-60D

ec 1

4

Jan 1

5

Fe

b 1

5

Mar

15

Ap

r 1

5

May 1

5

Jun 1

5

Jul 15

Aug 1

5

Sep 1

5

Oct 1

5

No

v 1

5

De

c 1

5

US$

bill

ion

, acc

um

ula

ted

in 1

2 m

on

ths

9 9

Revision for 2015 shows intensification in the deficit reduction:

• Estimate of the current account deficit from US$81 billion to US$65 billion (3.7% of GDP) for 2015.

o higher trade surplus, from US$3 billion to US$12 billion (deficit of US$6 billion in 2014) ;

o retreat of US$3 billion in the net expenses of profits and dividends, reaching US$18 billion

• The estimate of net inflows of direct investment liabilities (DIL) was reduced from US$80 billion to US$65 billion, totally financing the current transactions (CT)

• A net inflow of US$31 billion in stocks and securities in the country (denominated in BRL) is forecast, a reduction of US$10.5 billion relative to the previous estimate

• The rollover rate for securities and long-term loans, abroad, was maintained at 100%

Box: Balance of Payments Projections

103.6

81.0

65.0

96.9

80.0

65.0

0

20

40

60

80

100

120

2014 2015-Jun IRProj.

2015-Sep IRProj.

CT DIL

US$

bill

ion

Current Transactions and Direct Investment Liabilities (DIL)

2014: DIL financed 94% of the deficit

2015: DIL should finance 99% of the deficit

(accorging to the Jun-IR projection)

2015: DIL should finance 100% of the

deficit (according to the Sep-IR projection)

10 Sources: BCB and IBGE

Adjustment of Relative Prices: Regulated x Market Prices %

in 1

2 m

on

ths

0

3

6

9

12

15

18A

ug 0

4

Aug 0

5

Aug 0

6

Aug 0

7

Au

g 0

8

Aug 0

9

Aug 1

0

Aug 1

1

Aug 1

2

Aug 1

3

Aug 1

4

Aug 1

5

IPCA

Regulated IPCA

Market Prices IPCA

IPCA Reg. Market 2013 5.91 1.54 7.29 2014 6.41 5.32 6.72 2015 exp.* 9.34 15.20 6.78 2016 exp.* 5.70 5.91 5.61

*median of expectations on Sep 18th

• Regulated prices adjustment (15.75% in 12 months) is part of the fiscal adjustment (e.g., electricity tariffs, CIDE, etc.)

• Reduction of subsidies leads to the improvement of the public debt profile and of the allocation of resources in the economy (increase of the TJLP – long term interest rate, reduction in the loans to BNDES; PSI, etc.)

11 11

• The double adjustment of relative prices (regulated and external) impacts inflation in 2015, elevating 12-month accumulated inflation, and contributes for the improvement of the external account

• It is objective of the monetary policy to curb the transmission of this inflationary impact for 2016 and for longer terms

• The monetary policy can, should and is containing the second-order effects, to circunscribe them to 2015

• As a consequence, it should remain vigilant to ensure the convergence of inflation to the 4.5% target at the end of 2016

Prices Adjustments Impact Inflation, Current Account

12

-150

-100

-50

0

50

100

150

200

250

300

1/2/2015 2/12/2015 3/27/2015 5/12/2015 6/23/2015 8/3/2015 9/14/2015

2015

2016

2017

2018

2019

Source: BCB (Focus)

Expectations Anchored at the Medium Term (1) ch

ange

in b

p, s

ince

Jan

2

9.34

5.70 4.74

Medians on Sep 18

4.50 4.50

278 bp

0 bp

-76 bp

Change since Jan 2

-100 bp

. -50 bp*

vertical lines: Copom meetings, data through Sep 18th *for 2019, change since Jan 12th, 2015

13 Source: BCB (Focus)

IPCA

Expectations Anchored in the Medium Term (2)

*for 2019, expectation on Jan 12th, 2015

%

6.56

5.70 5.50 5.50

5.00

9.34

5.70

4.74 4.50 4.50

0

2

4

6

8

10

201

5

201

6

201

7

201

8

20

19

Jan 2

Sep 18

14 14

• The ongoing fiscal adjustment has already addressed several problems, such as the correction of regulated prices, expenses cuts and reduction of subsidies

• The earmarked credit and the implicit subsidies associated to it have been significantly reduced

• However, loss of strength in the economy, partially related to non-economic events, took to the frustration of incomes and deterioration of the fiscal scenario programmed for 2015

• Change in the parameters for the targets and PLOA (Yearly Budget Draft Law) were not in line with expectations and reflected in risk

• Therefore, the Monetary Policy needs fiscal anchorage to ensure the convergence of inflation to the 4.5% target at the end of 2016

Uncertainties of the Fiscal Adjustment Impact Risk Premia

15 Source: BCB

Fiscal Policy in Transition, Quasi-Fiscal Adjusting

• Real reduction of the expenses since the end of 2014

• But growth below the real incomes’ cycle

• Reduction of BNDES disbursements since the end of 2014

60

80

100

120

140

160

180

200

220

0

20

40

60

80

Jun 0

8

Jun 0

9

Jun 1

0

Jun 1

1

Jun 1

2

Jun 1

3

Jun 1

4

Jun 1

5

Finame (lhs) Total (rhs)

-10

-5

0

5

10

15

Jan 1

4

Feb

14

Ma

r 14

Apr

14

Ma

y 1

4

Jun 1

4

Jul 14

Aug 1

4

Sep 1

4

Oct 14

No

v 1

4

De

c 1

4

Jan 1

5

Feb

15

Ma

r 15

Apr

15

Ma

y 1

5

Jun 1

5

Jul 15

Net income Expenses

% a

ccu

mu

late

d in

th

e ye

ar

R$

bill

ion

R$

bill

ion

Real Growth (IPCA), Central Government

BNDES Disbursements in 12 Months

16

3.00

3.20

3.40

3.60

3.80

4.00

4.20

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

7/1

/2015

7/1

0/2

015

7/2

1/2

015

7/3

0/2

015

8/1

0/2

015

8/1

9/2

015

8/2

8/2

015

9/9

/2015

9/1

8/2

015

Expect. for the 2015 Primary Result Expect. for the 2016 Primary Result2015 Primary Target 2016 Primary TargetR$/US$

Source: BCB

Evolution of the Exchange Rate under the Effect of Expectations for the Primary Result

Revision of the Fiscal Targets

R$

/US$

Loss of the investment grade

by S&P Proposal of 2016 Budget Sent to the Congress

% o

f G

DP

expectations through Sep 18, other data through Sep 22nd

17 Source: Bloomberg

BRL/US$ Exchange Rate (Sep 23) Reflects Risk Premium

Annual

Last 5 days

18 Source: BMF&Bovespa

Yield Curve – Future DI, with Selic at 14.25%

12.5

13.0

13.5

14.0

14.5

15.0

15.5

% p

.a.

Jul 30 – Decision of the Copom and respective communiqué with “maintenance of interest rate level for a sufficiently long period”

Aug 31 – Proposal of 2016 Budget Sent to the Congress

Sep 4 – Perception of the risks’ market associated to the fiscal adjustment

Sep 10 – Brazil sovereign debt loses the investment grade by the risk agency Standard & Poor’s

1 year 2 years 3 years 4 years 5 years 6 years 7 years

Sep 10

Sep 4

Aug 31

Jul 30

19 Source: BCB

Exchange Rate (US$) in LA above the Dollar Index fx

rat

e –

DX

Y (

Jun

e 3

0=1

00

)

others = avg. (Argentina, Peru, Colombia and Uruguay), data through Sep 21st

Exchange Rate – Dollar Index

-5

0

5

10

15

20

25

30

Jun 30 Jul 08 Jul 16 Jul 24 Aug 01 Aug 09 Aug 17 Aug 25 Sep 02 Sep 10 Sep 18

Others Chile Mexico Brazil

20 20

• Context: prices’ realignments circumscribed to 2015; the trajectory of 12-month accumulated inflation will have significant discard effect in 1Q2016; lagged and cummulative effect of the Monetary Policy action

• Factor 1: Sharp fall in the activity, non-economic events. Transmission of the relative prices’ adjustment occurs with process of labor market distension; decrease in the intensity of prices’ adjustments pass-through (including exchange rate pass-through) in the current phase of the cycle

• Factor 2: More recent elevation of the risk premmia in the FX and interest markets; uncertainties about the intensity and promptness of the fiscal adjustment feed volatility

Balance of Risks for the 2016 Inflation

21 21

5.91%

0123456789

1011121314151617

jan

14

jul 1

4

jan

15

ago

15

201

5

201

6

Sources: IBGE and BCB (Focus)

% in 1

2 m

onth

s

Market expectations

from 2015 to 2016*

*position of Sep 18th

Context: Cumulative Regulated IPCA and Projected up to 2016

15.8%

22 Source: BCB (Focus)

Market Expectations for the GDP and Industrial Production

% o

f G

DP

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4O

ct 1

4

No

v 1

4

De

c 1

4

Ja

n 1

5

Fe

b 1

5

Ma

r 1

5

Ap

r 1

5

Ma

y 1

5

Jun 1

5

Ju

l 15

Au

g 1

5

Se

p 1

5

2015 Ind. Prod.

2016 Ind. Prod.

2015 GDP

2016 GDP

-2.70

Sep 18

-0.80

-6.45

0.20

Factor 1: Strong Deceleration of the Activity (GDP and Industrial Production)

vertical lines: Copom meetings

23 Source: BCB

Significant Changes between June and September in the Widening of the Output Gap (in %)

Copom/RI Junho Copom Julho Copom/RI SetembroJune Copom/IR

Factor 1: Effect of Activity in the wider Output Gap

Sep Copom/IR July Copom

24 Sources: IBGE and BCB

Factor 1: Ongoing Distension in the Labor Market (1) %

m/m

-12

gro

wth

% s

.a.

4.5

5.0

5.5

6.0

6.5

7.0

7.5

-5

-4

-3

-2

-1

0

1

2

3

4

Ja

n 1

3

Ma

r 13

Ma

y 1

3

Ju

l 13

Sep

13

Nov 1

3

Ja

n 1

4

Ma

r 14

Ma

y 1

4

Ju

l 14

Sep

14

No

v 1

4

Ja

n 1

5

Ma

r 15

Ma

y 1

5

Ju

l 15

real wages % (lhs) unemployment (rhs)

• Ongoing proccess accelerated; adjustments can occur as a combination of volume and price

• Return of young and elderly tend to contribute to the increase of productivity in the services sector

• Greater competition can benefit the adequacy betweeen wages and productivity; greater return regarding “years of education” creates incentives for improving human capital and productivity

25 Sources: IBGE and BCB

Factor 1: Ongoing Distension in the Labor Market (2)

Interannual change of the 3 Month-Moving Average

%

Population Real Wages

-4

-3

-2

-1

0

1

2

3

4

Ap

r 1

3

Ju

l 13

Oct 1

3

Ja

n 1

4

Ap

r 1

4

Ju

l 14

Oct 1

4

Ja

n 1

5

Ap

r 1

5

Ju

l 15

Employment Monthly Survey -formal jobs

Employment Monthly Survey -total

-2

-1

0

1

2

3

Ju

l 12

Oct 1

2

Ja

n 1

3

Ap

r 1

3

Ju

l 13

Oct 1

3

Ja

n 1

4

Ap

r 1

4

Jul 14

Oct 1

4

Ja

n 1

5

Apr

15

Ju

l 15

Occupied Population

Economically ActivePopulation

26 26

• Demographic evolution influenced several recent changes in the participation rate

• The box evidences that approximately one third of the retreat in the participation rate observed between the end of 2012 and the end of 2014 was due to the change in the composition of working-age population - PIA

• In 2015, the participation rates of young and elderly increased, with important impact in the total participation rate, which contributed to the acceleration in the growth pace of the unemployment rate.

Box: Effect of the Demography over the Participation Rate

-1.2

-0.8

-0.4

0.0

0.4

0.8

1.2

-2.4

-1.6

-0.8

0.0

0.8

1.6

2.4

201

1

201

2

201

3

201

4

201

5

Oc. Pop. Ec. Active Pop.

Unemployment rate (rhs) Participation rate (rhs)

%

Occupied Population, Economically Active Population, Unemployment and Participation

p.p

.

-0.8

0.0

0.8

1.6

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

10-17 18-24 25-39 40-59 60+

p.p

. an

nu

al c

han

ge

Composition of Working-Age Population

27 27

Factor 2: Risk Premmium, Brazil 5y CDS, BBBs and BBs basis

poin

ts

100

150

200

250

300

350

400

450

500

Jan 0

1 1

5

Jan 1

6 1

5

Ja

n 3

1 1

5

Fe

b 1

5 1

5

Mar

02 1

5

Mar

17 1

5

Apr

01 1

5

Apr

16 1

5

May 0

1 1

5

May 1

6 1

5

May 3

1 1

5

Jun 1

5 1

5

Jun 3

0 1

5

Jul 15 1

5

Jul 30 1

5

Aug 1

4 1

5

Au

g 2

9 1

5

Sep 1

3 1

5

Brazil BBs Avg. BBBs Avg.*through Sep 23rd

Source: IBGE

28 28

Box: Impact of Activity and Exchange Rate over Market Prices Inflation

• This box aims, especifically, at verifying how the cooling of the economic activity has contributed to offset the effects of the BRL depreciation over market prices inflation

• Demand shocks contributed negatively for the trajectory of market prices inflation, as opposed to the exchange rate shocks

• In net terms, the positive contribution of the exchange rate was higher than the negative contribution of the demand in around 1.5 p.p. in the first half (from a change of 4.50% of inflation in the same period)

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

Demand shock Exchange rate shock

Co

ntr

ibu

tio

n (

p.p

.)

Contribution of demand and exchange rate shocks over market prices

29 29

Debate and Box: Inflationary Inertia and Inflation Expectations

• This box evaluates the impact of the inertia and expectations components over the inflationary dynamics in Brazil

• The estimates suggest that the current inflation depends significantly on the past inflation

• In relation to the expectations term, the agents forecasts, for shorter terms, are strongly dependent on recent developments, mainly on inflation and on the exchange rate. For longer terms, the monetary stance and the inflation target gain importance.

4.4

4.6

4.8

5.0

5.2

5.4

5.6

5.8

Ju

l 14

Se

p 1

4

No

v 1

4

Ja

n 1

5

Ma

r 1

5

Ma

y 1

5

Ju

l 15

Se

p 1

5

2016

2017

2018%

30 30

• Adjustment in 2015 was occurring with improvement of fundamentals and perception: convergence to the inflation target, improvement of the external scenario, stable assets’ prices, improvement in the agents’ confidence

• Recent deterioration affected perceptions, increased risk premia and there was the downgrading of the sovereign grade; it is necessary to revert to the July 2015 scenario and to implement the proposed and debated additional adjustment fiscal program; essential condition for the success of the other components of the adjustment

• As a consequence, robust domestic market with low hanging fruits, investment opportunities that continue present

• Best contribution for the monetary policy to reduce volatility and to favor growth is to set inflation at the 4.5% target at the end of 2016 and anchor expectations in the medium and long terms

Current Situation demands Attention: Observe to Correct

31 31

Final Balance of Risks Sep 2015:

• Upward risks with the increase of risk and exchange rate premia

• Downward risks in terms of activity (e.g., acceleration in the process of distension in the labor market, moderation of demand and credit)

• Monetary Policy acted to address inflation, positioning the economy to face the normalization of the FED; in the current stress, it is necessary to have wisdom and calm to avoid excessive reaction; proceed with the already announced monetary policy, identifying possible excess in certain risk premia and remaining cautious regarding the implementation of the commitments relative to the fiscal component of the adjustment process

32

II. International Environment • Despite the signs of recovery in some advanced economies, the

decision about the normalization of the interest rates by the Fed shows more complex, opposing data that justify wait-and-see vis-à-vis risks to stay behind the curve

• Uncertainty and greater China factor (structural deceleration) can be adding higher volatility to the financial markets

• Ongoing moderation in the prices of commodities signals end of the hawkish super-cycle

• This context favors volatility, the strengthening of the US dollar relative to emerging markets’ currencies, questions the financial stability of emerging countries and suggests a process of adjustment in the exchange rate, monetary and fiscal areas; some net importing countries improve; the majority of them do not; Brazil is advanced in its homework

33 Source: IMF

Falling Commodities Prices in

dex

(2

00

5 a

vera

ge=1

00

)

Commodities Index and subindices calculated by the IMF

0

50

100

150

200

250

300A

ug 0

0

Aug 0

1

Aug 0

2

Aug 0

3

Aug 0

4

Aug 0

5

Aug 0

6

Au

g 0

7

Aug 0

8

Aug 0

9

Aug 1

0

Aug 1

1

Aug 1

2

Aug 1

3

Aug 1

4

Aug 1

5

Commodities Prices IndexFoodMetalsEnergy

34 Source: Bloomberg

US Dollar Vis-à-Vis Some Currencies

Data through Sep 18th; *dollar index: measures the international value of the dollar against basket of the six main reserve currencies in the world (Swiss franc, Canadian dollar, Japanese yen, pound sterling, euro and Swedish kron)

ind

ex (

5/2

1/1

3=1

00

)

70

75

80

85

90

95

100

105

110

115

120S

ep

13

Nov 1

3

Jan 1

4

Mar

14

May 1

4

Jul 14

Sep 1

4

Nov 1

4

Jan 1

5

Mar

15

Ma

y 1

5

Jul 15

Sep 1

5

Dollar index*

Index of 20 emerging currencies

Euro

Yen

35 35

• Since 2Q2015, the risk aversion increased due to:

• difficulties in the negotiations with Greece;

• retreat in the Chinese stocks markets and floating of the local currency;

• retreat in the commodities prices; and

• uncertainties regarding the liftoff in the US

• This context includes:

• heterogeneous economic recovery in G3;

• devaluation of emerging economies’ and commodities exporters’ currencies.

Retrospective – Abroad (since 2Q2015)

36 36

• Throughout the relevant horizon for the monetary policy, prospects for asymmetric growth inside the G3 (e.g., improvement in the US, QE in Europe and in Japan), and low growth in the emerging economies.

• More rigid funding conditions for the majority of the emerging economies.

Prospects – Abroad 2015-2016

37 Sources: U.S. BEA; Federal Reserve and U.S. BLS

Economic Recovery in the US

% o

f th

e t

ota

l (s.

a.)

% q

/q-4

ch

ange

nonfarm payroll employment (seasonally adjusted)

mill

ion

65

70

75

80

85

-6

-4

-2

0

2

4

6

GDP

Capacity Utilization

100

110

120

130

140

150

Jun 9

5

Jun 9

7

Jun 9

9

Jun 0

1

Jun 0

3

Jun 0

5

Jun 0

7

Jun 0

9

Jun 1

1

Jun 1

3

Jun 1

5

38 Source: Bloomberg

Europe – Growth and Inflation %

q/q

-4 ,

s.a.

GDP Growth – Euro Area Consumer Inflation – Euro Area

% in

12

mo

nth

s

0.10

-1

0

1

2

3

4

Au

g 0

7

Au

g 0

8

Au

g 0

9

Au

g 1

0

Au

g 1

1

Au

g 1

2

Au

g 1

3

Au

g 1

4

Au

g 1

5

1.50

-6

-5

-4

-3

-2

-1

0

1

2

32Q

08

4Q

08

2Q

09

4Q

09

2Q

10

4Q

10

2Q

11

4Q

11

2Q

12

4Q

12

2Q

13

4Q

13

2Q

14

4Q

14

2Q

15

39

6

7

8

9

10

11

12A

ug 1

0

Fe

b 1

1

Aug 1

1

Fe

b 1

2

Aug 1

2

Fe

b 1

3

Aug 1

3

Fe

b 1

4

Aug 1

4

Fe

b 1

5

Aug 1

5

GDP leading indicator

real GDP growth

Source: Bloomberg

China – Gradual Deceleration %

m/m

-12

ch

ange

, % q

/q-4

ch

ange

40 Source: Bloomberg

China: Stock Market and Change of Exchange Rate Regime

1000

2000

3000

4000

5000

6000

6.0

6.2

6.4

6.6

Sep 1

3

Dec 1

3

Mar

14

Jun 1

4

Sep 1

4

Dec 1

4

Mar

15

Jun 1

5

Sep 1

5

Exchange rate (Yuan)

Shangai Composite

Yuan

/US$

41 Fonte: Bloomberg

Volatility

data up to Sep 18th

% p

.y.

% p

.y.

VIX and Volatility in Securities Markets

Currency Volatility

bp

s

40

50

60

70

80

90

100

110

120

10

20

30

40

50S

ep

12

Nov 1

2

Ja

n 1

3

Ma

r 13

Ma

y 1

3

Ju

l 13

Sep

13

Nov 1

3

Ja

n 1

4

Ma

r 14

Ma

y 1

4

Ju

l 14

Sep

14

Nov 1

4

Ja

n 1

5

Ma

r 15

Ma

y 1

5

Ju

l 15

Sep

15

VIX

MOVE

4

8

12

16

20

24

28

Sep

12

No

v 1

2

Ja

n 1

3

Ma

r 13

Ma

y 1

3

Ju

l 13

Sep

13

Nov 1

3

Ja

n 1

4

Ma

r 14

Ma

y 1

4

Ju

l 14

Sep

14

Nov 1

4

Ja

n 1

5

Ma

r 15

Ma

y 1

5

Ju

l 15

Sep

15

BrazilIndiaSouth Africa

42

III. Financial Conditions

• Moderation in the pace of credit concession consistent with the adjustment process and position of the economy in the cycle

• Robustness and soundness of the National Financial System (e.g., capital, provisions and liquidity) remain and ensure financial stability

• Stability of the credit growth has not brought higher delinquency level

43

25.6 25.8 24.3 25.5

28.0 30.4

34.7

39.7 42.7

44.1 46.5

50.3 52.6

54.7 54,6

0

10

20

30

40

50

602

00

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

20

14

201

5*

Source: BCB

Credit/GDP Ratio %

of

GD

P

new methodology as of 2011; *Aug 15

2009-2014: 16.1% (average nominal growth)

2005-2008: 25.4% (average nominal growth)

44 Source: BCB

Credit and Delinquency

Expansion of Credit Outstanding

Delinquency

%

% c

han

ge in

12

mo

nth

s

2.7

2.9

3.1

3.3

3.5

3.7

3.9

Au

g 1

1

De

c 1

1

Apr

12

Au

g 1

2

De

c 1

2

Ap

r 1

3

Au

g 1

3

De

c 1

3

Ap

r 1

4

Au

g 1

4

De

c 1

4

Apr

15

Au

g 1

5

8

10

12

14

16

18

20A

ug

11

De

c 1

1

Ap

r 1

2

Au

g 1

2

De

c 1

2

Ap

r 1

3

Au

g 1

3

De

c 1

3

Ap

r 1

4

Au

g 1

4

De

c 1

4

Ap

r 1

5

Au

g 1

5

45 Source: BCB

Declining Household’s Debt

% o

f th

e in

com

e

% o

f th

e an

nu

al in

com

e

18

19

20

21

22

27

28

29

30

31

32Jun 1

0

Dec 1

0

Jun 1

1

Dec 1

1

Jun 1

2

Dec 1

2

Jun 1

3

Dec 1

3

Jun 1

4

Dec 1

4

Jun 1

5

Debt ex-housing

Debt service ex-housing

46 Source: IMF (FSI – last available data)

Financial Soundness Indicators

12.5

12.6

12.9

13.6

14.1

14.1

14.2

14.6

15.0

15.3

15.3

15.4

15.5

15.5

16.6

17.4

0 5 10 15 20

India

Australia

Russia

Canada

Spain

US

Korea

South Africa

Italy

Japan

Mexico

France

Brazil

Turkey

UK

Germany

Basle Index

-38.0

-20.2

-18.4

-17.3

-14.3

-9.6

-8.5

-8.1

-5.6

-3.8

-3.8

4.0

10.9

-50 -40 -30 -20 -10 0 10 20

Spain

Russia

South Africa

India

Japan

Australia

UK

US

Canada

Korea

Turkey

Mexico

Brazil

(Provisions – Delinquency)/ Capital

24.8

34.7

38.7

39.9

41.2

46.6

48.9

79.1

92.4

96.9

118.4

122.6

142.1

187.3

0 70 140 210

India

South Africa

Japan

UK

Australia

Mexico

Canada

Turkey

Russia

US

Korea

Italy

German

Brazil

Net Assets/ Short-Term Liabilities

47

IV. Activity

• 2015 is a year of adjustment, with impact on the activity and growth rates that tend to be low (below potential); reduction in the private consumption is additional factor of contraction

• Non-economic events are added to the contraction cycle and contribute to additional fall of investment; differences among projections are explained through different methods to evaluate these events

• Recovery will happen only as confidence improves

48 Sources: IBGE and Funcex

Supply: Low Dynamism

Industrial Production Services Nominal Income

Crop Harvest Imports Quantum

% 1

2m

/pre

vio

us

12

m

% y

/y-1

% m

/m-1

2, 3

mm

a

% 1

2m

/pre

vio

us

12

m

2015: IBGE estimates in Aug/15

-5.3 -6

-5

-4

-3

-2

-1

0

1

2

3M

ar

12

Ju

l 12

Nov 1

2

Ma

r 13

Ju

l 13

Nov 1

3

Ma

r 14

Ju

l 14

Nov 1

4

Ma

r 15

Ju

l 1516.3

2.7

8.6

-10

-5

0

5

10

15

20

25

30

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

-8.4

-9

-6

-3

0

3

6

9

Apr

12

Aug

12

Dec 1

2

Apr

13

Aug

13

De

c 1

3

Apr

14

Aug

14

Dec 1

4

Apr

15

Aug

15

1.8

0

2

4

6

8

10

12

14

Ma

r 12

Ju

l 12

Nov 1

2

Ma

r 13

Ju

l 13

Nov 1

3

Ma

r 14

Ju

l 14

Nov 1

4

Ma

r 15

Ju

l 15

49 Sources: IBGE and Funcex

Demand: Moderation in Line with Adjustment

Household Consumption FCGF

Government Consumption Exports Quantum

% c

han

ge in

4 q

uar

ters

% 1

2m

/pre

vio

us

12

m

% c

han

ge in

4 q

uar

ters

% c

han

ge in

4 q

uar

ters

-0.6

-1

0

1

2

3

4

5

6

72

Q 1

1

4Q

11

2Q

12

4Q

12

2Q

13

4Q

13

2Q

14

4Q

14

2Q

15

-7.9

-10

-5

0

5

10

15

2Q

11

4Q

11

2Q

12

4Q

12

2Q

13

4Q

13

2Q

14

4Q

14

2Q

15

-0.3 -0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2Q

11

4Q

11

2Q

12

4Q

12

2Q

13

4Q

13

2Q

14

4Q

14

2Q

15

0.4

-4

-2

0

2

4

6

8

Apr

12

Aug

12

Dec 1

2

Apr

13

Aug

13

Dec 1

3

Apr

14

Aug

14

Dec 1

4

Apr

15

Aug

15

50 Source: FGV

Consumer Confidence (ICC): Stabilization of Decrease

Note: Proportion of favorable answers – proportion of unfavorable answers + 100 (100=neutral)

Sep

/05

=10

0, s

.a.

Consumer Confidence Index

70

75

80

85

90

95

100

105

110

115

120

125A

pr

13

Jun 1

3

Aug 1

3

Oct 1

3

Dec 1

3

Fe

b 1

4

Apr

14

Jun 1

4

Aug 1

4

Oct 1

4

Dec 1

4

Fe

b 1

5

Apr

15

Jun 1

5

Aug 1

5

ICC

Current Situation

Expectation

51

Box: GDP Projection

• Revision of the 2015 growth rate, from -1.1% to -2.7% (domestic demand, -5.1 p.p.; and net exports, +2.4 p.p.):

• Supply:

• Agriculture and livestock: 2.6% (1.9% in 2Q2015)

• Industry: -5.6% (-3.0% in 2Q2015)

• Services: -1.6% (-0.8% in 2Q2015)

• Demand:

• Investment: -12.3% (-7.0% in 2Q2015)

• Households’ Consumption: -2.4% (-0.5% in 2Q2015)

• Government Consumption: -1.4% (-1.6% in 2Q2015)

• A 2.2% retreat in the four quarters ending in June 2016

52

V. Inflation Developments • The double relative prices adjustment (regulated and external)

impacted inflation in the first half of 2015, increasing the 12-month accumulated inflation; the objective is to avoid its transmission to 2016 and longer terms, being necessary the maintenance of the current level of the Selic rate, for a sufficiently long period

• There was deterioration in the balance of risks for inflation, but, as it is not possible to ensure today if the recent elevations of risk premia are temporary or permanent, this demands that the monetary policy, from the one hand, observe with attention the causes of volatility and, on the other hand, remain vigilant in case of significant deviations of the Copom inflation projections relative to the target

53

Inflation Developments: Led by Regulated Prices

Sources: IBGE and FGV

change in 12 months (%)

Aug/14 Aug/15

IPCA 6.51 9.53 ▲

Market 6.95 7.70 ▲

Regulated 5.07 15.75 ▲

Tradables 6.81 6.62 ▼

Non-Tradables 7.07 8.60 ▲

INPC 6.35 9.88 ▲

IPC-C1 6.22 10.37 ▲

IGP-DI 4.63 7.80 ▲

IPA-DI 3.41 7.15 ▲

Agriculture 1.91 10.45 ▲

Industrial 3.97 5.94 ▲

IPC-DI 6.76 9.73 ▲

INCC-DI 7.26 7.30 ▲

54

% in

12

mo

nth

s Prices: Slow Adjustment in Non-Tradables

Sources: BCB, IBGE and FGV

Inflation (IPCA) Wholesale Prices and IGP

Services Inflation

% in

12

mo

nth

s %

in 1

2 m

on

ths

% in

12

mo

nth

s

Market and Regulated Prices

8.2

7.7

7.9

8.1

8.3

8.5

8.7

8.9

9.1

9.3

Aug

12

Nov 1

2

Fe

b 1

3

Ma

y 1

3

Aug

13

Nov 1

3

Fe

b 1

4

Ma

y 1

4

Aug

14

Nov 1

4

Fe

b 1

5

Ma

y 1

5

Aug

15

8.6

6.6

2

4

6

8

10

Aug

12

Nov 1

2

Feb 1

3

Ma

y 1

3

Aug

13

Nov 1

3

Feb 1

4

Ma

y 1

4

Aug

14

Nov 1

4

Feb 1

5

Ma

y 1

5

Aug

15

non-tradables

tradables

7.7

15.8

0

2

4

6

8

10

12

14

16

Aug

12

No

v 1

2

Feb 1

3

Ma

y 1

3

Aug

13

No

v 1

3

Feb 1

4

Ma

y 1

4

Aug

14

No

v 1

4

Feb 1

5

Ma

y 1

5

Aug

15

market

regulated

0

2

4

6

8

10

Dec 1

2

Ma

r 13

Ju

n 1

3

Sep

13

Dec 1

3

Ma

r 14

Ju

n 1

4

Sep

14

Dec 1

4

Ma

r 15

Ju

n 1

5

Sep

15

IPP

IPA

IGP

7.82% IGP-10

Sep 2015 7.62%

IPP Jul 2015 7.37%

IPA-10 Sep 2015

55 Sources: IBGE and MTE

Wages: Adjustments in Progress, but still Risks av

erag

e an

nu

al in

crea

se %

Real Wages

* 12m through July

real

ad

just

men

t %

Labor Collective Conventions

-1.6 -2.0

-1.0

0.0

1.0

2.0

3.0

Fe

b 1

3

Aug

13

Fe

b 1

4

Aug

14

Fe

b 1

5

Aug

15

4.0

3.2 3.4 3.2

3.8

2.7

4.1

1.8

2.7

-0.2

-0.5

0.5

1.5

2.5

3.5

4.52

00

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5*

56 56

• Despite the absence of disinflationary contribution of the exchange rate, the market expectations indicate disinflation of 4 p.p. through the end of 2016, around 80% of the necessary to ensure the convergence to the target

• In May 2003 (peak of the cycle 2002/2004), the expectations signaled disinflation of 9 p.p. for the twelve months ahead - around 75% of the 12 p.p. disinflation that really occurred.

Box: Comparison of Desinflation Cycles

4

6

8

10

12

14

16

18

M-1

8

M-1

6

M-1

4

M-1

2

M-1

0

M-8

M-6

M-4

M-2

M0

M+

2

M+

4

M+

6

M+

8

M+

10

M+

12

M+

14

M+

16

M+

18

2002/2004 Cycle 2014/2016 Cycle

Set 11, 2015 Focus May 30, 2003 Focus

% in

12

mo

nth

s

IPCA and Focus projections

57 Source: BCB

Baseline Scenario: Interest rate constant at 14.25% p.y. and exchange rate of R$3.90/US$

BCB Inflation Forecasts

Obs.: 12-month accumulated inflation (% p.y.)

Period

Probability interval

Central projection

50%

30%

10%

2015 3 9.4 9.4 9.5 9.5 9.6 9.6 9.5

2015 4 9.2 9.3 9.5 9.6 9.8 9.9 9.5

2016 1 7.0 7.3 7.5 7.8 8.0 8.3 7.7

2016 2 5.7 6.0 6.3 6.6 6.9 7.2 6.5

2016 3 4.9 5.2 5.6 5.9 6.3 6.7 5.8

2016 4 4.4 4.8 5.2 5.5 5.9 6.3 5.3

2017 1 3.8 4.2 4.6 5.0 5.3 5.7 4.8

2017 2 3.7 4.1 4.5 4.8 5.2 5.6 4.7

2017 3 3.1 3.5 3.9 4.2 4.6 5.0 4.0

58 Source: BCB

BCB Inflation Forecasts

Market Scenario: 2015 Interest rate at 14.25% p.y. and avg. exchange rate of R$3.86/US$ 2016 Interest rate at 12.25% p.y. and avg. exchange rate of R$4.00/US$

Period

Probability interval

Central projection

50%

30%

10%

2015 3 9.4 9.4 9.5 9.5 9.6 9.6 9.5

2015 4 9.2 9.3 9.5 9.6 9.8 9.9 9.5

2016 1 7.1 7.3 7.5 7.8 8.0 8.2 7.7

2016 2 5.7 6.0 6.3 6.6 6.9 7.2 6.4

2016 3 4.9 5.3 5.6 6.0 6.3 6.7 5.8

2016 4 4.5 4.9 5.3 5.6 6.0 6.4 5.4

2017 1 4.1 4.5 4.9 5.2 5.6 6.0 5.1

2017 2 4.2 4.6 4.9 5.3 5.6 6.0 5.1

2017 3 3.7 4.1 4.5 4.8 5.2 5.6 4.6

59

Analysis of the 193rd Copom Minutes Remains Adequate

The Copom evaluates that the inflation convergence scenario to 4.5% at the end of 2016 has remained, despite some deterioration in the balance of risks. The Committee understands that the maintenance of the basic interest rate at 14.25% p.a., for a sufficiently long period, is necessary for the convergence of inflation to the target at the end of 2016.

For the Committee, on the one hand, the advances reached in the fight against inflation show that the strategy of monetary policy is in the correct direction. Under this view, certain remaining risks for the Copom inflation projections to reach safely the objective of 4.5% at the end of 2016 are in line with the lagged and cumulative effect of the monetary policy action. On the other hand, recent elevations of the risk premia that reflect in the prices of assets demand that the monetary policy remains vigilant in case of significant deviations of the Copom inflation projections in relation to the target.

60

Inflation Outlook

Thank you! Inflation Report September 2015