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In the coming days, the evolution of the exchange rate will be fundamental in the inflation projections that will support the decision of the Monetary Policy Committee (Copom) of the Central Bank next week.
An appreciated real against the dollar, as seen earlier last week, may help the Central Bank to show an inflation projection less distant from the 2023 target and therefore reduce the pressure for a stronger monetary tightening.
On Friday, however, the real weakened sharply against the dollar as a result of a signal from Federal Reserve Chair Jerome Powell that a 50 basis points hike in U.S. benchmark interest rates is on the table.
The Brazilian Central Bank intervened in the exchange rate, with a sale of $571 million. The action was justified to maintain functionality in the exchange rate, in a market session squeezed in the middle of a long holiday. But in the end, it prevented a further weakened real.
Another doubt is the uncertainties about the Chinese economy, with the prospect of a more severe lockdown being enacted in Beijing to contain the latest wave of coronavirus contagion in the country. Iron ore prices dropped about 10% on Monday.
The exchange rate has no direct relation with monetary policy, but has gained prominence recently for two reasons.
One was Central Bank President Roberto Campos Neto’s remarks that market sectors were not taking into account the new, lower exchange rate in their inflation projections.
There hasn’t been a reliable indicator of market projections for inflation since March 25, when the Central Bank servants’ strike began. The Central Bank promises to release the Focus survey this Tuesday. But informal surveys, such as that of XP Investimentos, indicate that the market’s inflation projection for 2023 may have risen to 4%, against an inflation target of 3.25% for the year.
Another fact that gives greater visibility to the exchange rate, within monetary policy decisions, is that the so-called pass-through of exchange rate variations into inflation has increased.
A 10% rise in the exchange rate leads to a maximum effect of 1.1 percentage points on inflation 12 months ahead. In the longer term, between 18 and 21 months, this effect falls to somewhere between 0.6 and 0.7 percentage points.
It can make a big difference. Last week, the exchange rate even oscillated around R$4.6 to the dollar, or 8% below the market consensus, which informal surveys indicate is close to R$5 to the dollar.
This translates into an inflation projection about 0.5 percentage point lower for 2023. It may help the Copom to present an inflation projection closer to the target.
The expected inflation under relative control, in turn, would avoid taking the benchmark interest rate much further over the 12.75% per year signaled by the Copom in March for the end of the monetary tightening cycle.
Source: Valor International