With arrival of new directors, BC communication will be point of attention
07/31/2023
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Fernando Rocha — Foto: Leo Pinheiro/Valor
The market begins the week with the certainty that the Monetary Policy Committee (Copom) of the Central Bank will begin a cycle of interest rate cuts at Wednesday’s meeting. However, experts are divided on the size of the benchmark interest rate Selic cut, with those expecting 0.25 points cut and those expecting 0.5 points cut.
If the decisions of Copom are already in the focus of market participants, Wednesday’s meeting promises to be even more in the spotlight. The beginning of a cycle of monetary easing is certain, but the size of the adjustment to be promoted by the collegiate is a point that divides the experts, who also do not indicate a consensus regarding the Copom’s vote and the communication of the collegiate. For some, the decision may be unanimous, but a group expects dissent with the arrival of new directors on the committee.
In the survey carried out between July 25 and 28 by Valor with 128 financial institutions and consultant firms, 82 companies (or 64.6% of the total) project a reduction of 0.25 percentage points in Selic, which is already starting to say goodbye to 13.75% after almost a year at this level. The bet on 0.5 points decrease in the key interest rate is defended by 44 companies (or 34.6% of the total).
The consensus in the economists’ expectations for Selic differs from what is priced in the market. Digital options for Wednesday’s decision indicated, at Friday’s close, a 55% probability of 0.5 points cut and a 42% probability of 0.25 points cut.
There are many reasons for the division and uncertainty in the market over the outcome of Wednesday’s Copom meeting. The arrival of directors Gabriel Galípolo and Aílton Aquino to the committee adds to the unpredictability, while the economic scenario confirms the tone of doubts of the agents.
On the one hand, there has been a favorable evolution in inflation dynamics, with current prices on a softer trajectory and a reduction in the degree of de-anchoring of medium and long-term expectations. In addition, signs of a slowdown in economic activity have been accumulating and Brazil’s risk premiums have declined further in recent weeks. On the other hand, there are still doubts about the strength of the labor market and the dynamics of inflation in services, while the communication of the Central Bank has indicated a cautious approach to cuts.
“There are good arguments for both sides,” said Fernando Rocha, chief economist at JGP, who sees room for a faster start of the easing cycle and expects most Copom members to opt for a 0.5-point cut in the Selic. “I think that in the last meeting, the discussion in the collegiate for the August decision was about 0.25 points cut or keeping the Selic unchanged. I think there will be an evolution: those who were thinking about a hold may see room for 0.25 points cut and those who were expecting 0.25 points cut in June may vote for 0.5 points cut.”
Mr. Rocha, therefore, says he expects a result that shows a division of the directors of the Central Bank but points out that the level of uncertainty in the expectation for the decision is high. “It’s a meeting that has left opinions well divided in the market,” he said.
Regarding the market sentiment for the meeting, there is a vagueness about the distribution of votes in the Copom, which feeds the doubts about the decision itself. There are market agents who are expecting a sharp split in the committee; there are those who think that only the two new members of the collegium will vote differently; and there is a section of agents who are hoping that the president of the Central Bank, Roberto Campos Neto, can reach a consensus in the collegiate.
BTG Pactual’s survey of 107 market participants, including economists, traders, asset managers, and strategists, shows that the majority of respondents (70%) believe in a split decision on Wednesday.
Roberto Padovani, the chief economist at Banco BV, shares the sense of uncertainty surrounding the decision. In his baseline scenario, he expects a reduction of 0.25 points in the Selic, in line with the consensus of market economists, emphasizing the behavior of core inflation and services inflation, whose levels are still incompatible with achieving the target.
According to Mr. Padovani, nominal interest rates are so high at the neutral level that the Central Bank could start the cycle with 0.5 points cut, “which would be a reasonable pace.” However, there would be an additional difficulty in communication, in his view. “If the BC starts with a 0.5-point cut, the market will probably think that the Copom will accelerate to a higher pace. I think it’s a strategy of adjusting expectations, and the option of a 0.25-point cut would be to show that there are still challenges.”
As examples, Mr. Padovani cited the slow disinflation of services prices; the uncertainty about the impact of El Niño, and the doubts that keep medium- and long-term inflationary expectations unanchored in the Focus Survey.
So, for Mr. Padovani, the communication should sound like a “hawkish” (conservative) rate cut. “How does he put that together? Exactly by pointing out that core inflation is high, and that disinflation is slowing, and by warning that the anchoring of expectations is not complete and that this requires, therefore, a vigilant stance.”
This view is similar to that of Marcelo Fonseca, the chief economist at Reag Investimentos. Although he believes the easing cycle may start with a modest Selic cut of 0.25 points, Mr. Fonseca expects the Copom to deliver a cut of 0.5 points. “We still have problems. The service cores are much higher than the target. In addition, nominal wages are at a very high level, which is an additional difficulty for disinflation in services prices,” he said.
Nevertheless, the Reag economist cites three reasons that could underpin the more aggressive rate cut, which is considered in his scenario: a more evident slowdown in economic activity; the tightness of monetary conditions, with real interest rates well above the neutral level; and a Central Bank assessment of the overall easing cycle that could allow for a faster start to the cuts. “The ‘implicit budget’ in Focus is around 4 points. Thus, 0.5 points curt would be a more compatible step.”
The high level of interest rates and the large “budget” of cuts ahead are points cited by the chief economist of Bocom BBM, Cecília Machado, to defend a reduction of 0.5 points in the interest rate. She also emphasizes that there has been an improvement in the scenario.
“The Central Bank wanted to see longer inflation expectations converge to the target, it wanted to see a slowdown in activity consistent with the degree of tightening already produced and it wanted to have more confidence in the process of disinflationary dynamics,” she said. And on all three counts, Ms. Machado said, there were significant improvements.
“The target was kept at 3% and after that, we saw some convergence in long-term expectations. The second point is related to the slowdown in the economy, and we are already seeing signs that monetary policy is working. You can ask whether it’s enough, but the trajectory is towards cuts,” he said.
*Por Victor Rezende, Gabriel Roca — São Paulo
Source: Valor International