The Focus bulletin of financial market expectations, released on Monday, indicates that neutral interest rate estimates are on the rise, above 4% a year. This trend, if confirmed, means that the Central Bank will have to define a higher Selic, Brazil’s benchmark interest rate, in the coming years to keep inflation in check.
The market increased, for the second week in a row, its estimate for the nominal interest rate in 2024, to 7.38% a year from 7.25% a year. This means a real interest rate of about 4.38%, considering the 3% inflation target set by the government for the long term.
This percentage exceeds the estimate of a neutral interest rate of 4% a year given by the market in a survey answered by private-sector analysts in December, on the eve of the meetings of the Central Bank’s Monetary Policy Committee (Copom).
The Central Bank itself estimates a neutral interest rate of 3.5% a year, as disclosed in the Inflation Report last month. But the monetary authority assigns a relatively high probability that the percentage will be higher than that, since it considers that fiscal fragility increases the risk of a higher neutral rate.
The year 2024 is far enough away to leave the most immediate horizon of monetary policy, so the interest rate estimated by the market for the period is a kind of approximation of the economy’s neutral rate.
Today, the Central Bank’s attention is focused on meeting the inflation target mainly for 2023 and, to a lesser extent, 2022. The real interest rate that will be in effect in 2024 will be focused on guaranteeing the fulfillment of the inflation target in 2025.
The increase in the projection for the interest rate in 2024 may reflect, besides an eventual increase in the neutral interest rate, a market view that the fight against inflation may be longer than expected, amid a greater resistance in the rise of global prices.
A sign of these difficulties is that the inflation projection for 2024 also rose for the second week in a row, to 3.09% from 3.04%. The rise, however, is smaller than the advance in nominal interest rates in the period, which reinforces the view that the rise in neutral interest rates may be behind the revision of the outlook for the Selic in the period.
The median projection for the Selic rate for the following years remains at 7% per year. But there are previous signs that it may be on an upward trajectory. The average of the projections for 2025 rose to 7.17% from 7.1%. In the case of projections for 2026, it rose to 7.07% from 6.9%.
It is difficult to determine exactly what is causing the higher estimates for the neutral interest rate. Judging by the December survey, two factors may be playing a role: the increase in fiscal risk and the more challenging international scenario.
This year, the government has once again considered new measures that weaken the fiscal situation, such as tax cuts for fuels and for the industrial sector, in a period in which the government still faces a fiscal deficit. The prospect of interest rates being raised by developed countries also creates uncertainty about the level of interest rates that will prevail worldwide in the long term.
Source: Valor International