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Central Bank’s Focus survey of market expectations, which was released Tuesday morning, was more or less within the expectations, but the high inflation projected for 2023 poses a challenge for the Monetary Policy Committee (Copom).
The inflation expected by the market was 4%, well above the target set for the year, of 3.25%, on a horizon that is the main target of monetary policy.
The Focus Survey is not surprising because informal surveys carried out by the market during the Central Bank civil servant’s strike, when these statistics ceased to be released, also pointed to inflation around 4% in 2023.
But the distance of the projections from the target, 0.75 percentage points, is very large. The additional dose of interest to bring this projected inflation to the target is significant. Each 0.26 percentage point drop in inflation requires an additional 100 basis points of interest rate tightening.
These inflation projections take into account the policy interest rate Selic rate of 13.25% per year at the end of the monetary tightening cycle. Therefore, to bring inflation to the target in 2023, it would be necessary to raise interest rates to a little more than 16% a year. Nobody thinks that the Central Bank will do this. The highest Selic rate projected by the market is 14.25% per year.
When calibrating monetary policy, the Central Bank does not need to follow market projections exactly. What counts is the Copom’s own projection, made with its own models. In the March meeting, the Copom reached an expected inflation close to the 2023 target, of 3.25%, while the market was already projecting 3.7%.
However, with the new rise in market inflation expectations, it is more difficult for the Central Bank to maintain its inflation projection around the target. Economic analysts are increasingly questioning the Central Bank’s forecasts, which have rarely strayed so far from the expectations contained in the Focus survey.
There are some factors that could make the Central Bank’s projection fall short of Focus expectations, but not that much. One is the exchange rate. The monetary authority works with the prospect that the rate will remain basically stable at current levels (it was over R$4.9 to the dollar on Tuesday), while the market considers a median rate of R$5 for the end of this year.
The good news for the Central Bank is that, despite the worsening of inflation expectations for 2023, market projections for the following year remained stable at 3.2%. The percentage is above the target of 3%, but the fact that it has not worsened (keeping it somewhat immune from the more general deterioration in the inflationary scenario in the short term) is still positive.
The market has also not increased much its projection for the interest rate at the end of the tightening cycle. Tuesday’s Focus survey shows it at 13.25%. What has increased the most is the interest rate forecast for the end of 2023. In March, it was 8.25%, and now it is 9%.
In other words, the overall Focus projections say that the market does not really believe that the Central Bank will pursue the 2023 target. Because of this, the inflation projected for next year is well above the target, and the final breath of this monetary tightening cycle is relatively restricted.
But, on the other hand, analysts think that the Central Bank will manage to have good control of inflation in 2024, if it postpones the monetary easing cycle planned for next year.
Source: Valor International