A scenario that was already difficult for the disinflation process took on even more complex contours, which is ex require a higher interest rate. The significant worsening of the balance of risks for inflation, in the wake of the war in Ukraine, knocks on the door of the Monetary Policy Committee (Copom) of the Central Bank, which is expected to raise the Selic, Brazil’s benchmark interest rate, again this week. While the prevailing assessment is that of a slower tightening now, the new challenges already signal the need for a higher base rate ahead.
In its last three decisions, the Copom promoted increases of 150 basis points in the Selic, but signaled that, at this week’s meeting, the magnitude of the rise should decrease. With the basic interest rate at 10.75%, the market believed the signal from the monetary authority and, of 93 financial institutions consulted by Valor between March 10 and 11, 82 expect the Selic to be raised by 100 bp, to 11 .75%.
The worsening of the inflationary scenario, however, made nine institutions project a 125 bp increase, while two – Austin Rating and UBS BB – believe that the committee will maintain the pace of interest rate hikes at 150 bp at the Wednesday meeting.
Despite this, it is clear to the market that the scenario has worsened significantly. Valor also consulted institutions about inflation this year and in 2023. The survey, conducted on Thursday, covered scenario revisions that took place after the fuel price hike by Petrobras and after a new surprise observed in Brazil’s benchmark inflation index IPCA in February. If, in the previous survey, the midpoint of the estimates indicated inflation at 5.2% this year, now the expectation is that the IPCA will close 2022 at 6.5%.
It is worth remembering, however, that this week’s Copom meeting is expected to be the last in which the 2022 calendar year will continue to be considered in the relevant horizon for the performance of monetary policy. The deterioration of expectations for 2023, which become more important, also triggers a warning signal. In February, the median indicated the IPCA at 3.4% at the end of next year and, now, the midpoint of the projections is at 3.8%.
Part of the market also adjusted its estimates for the Selic and began to see a higher rate ahead. In the Valor survey, the median of 91 projections collected points to the Selic at 12.75% at the end of the cycle (compared to 12.25% in the previous survey). A relevant part of the market, however, believes that the basic interest rate can reach at least 13% – which was stated by 44 institutions (48.3% of the total).
“When we think about the design of monetary policy from now on, we see that the Central Bank is dealing with an increasingly persistent inflation,” says Gustavo Arruda, BNP Paribas’ head of economic research for Latin America. “With a new shock on top of already high current inflation and inflation expectations above the target, what the Central Bank should do is continue in action, and that means raising interest rates for longer.”
Last week, the French bank raised its forecast for the Selic to 13.25% from 12.25% at the end of the cycle, which would take place in June. “It’s not a big change of scenery, it’s 100 bp higher. I believe that this is an adjustment for the Central Bank to coordinate inflation expectations and avoid the transmission of these shocks throughout the economy,” says Mr. Arruda.
Despite the deterioration of the inflationary scenario, the vast majority of agents continue to see a 100-point rise in the Selic rate this week as the most likely move. This is the case of Apex Capital’s chief economist Alexandre Bassoli, who projects the basic interest rate at 12.75% at the end of the current cycle.
Although he emphasizes that monetary policy “still has a lot of work to do to make inflation converge to the targets,” Mr. Bassoli still expects a deceleration in the pace of the Selic increase, from 150 bp to 100 bp, when considering the lagged effect of interest rates. “We have already advanced a lot in the cycle here in Brazil and, considering the uncertainties, this Copom guideline to produce a deceleration in the pace of growth seems reasonable. But there is still work to be done,” he emphasizes.
The economist recalls that the Copom had already mentioned “next adjustments”, in the plural, and, in the current context, there is a suggestion that the hike to be carried out this week will not be the last. “We have at least one more to go. I would expect at least two more,” he says. According to Mr. Bassoli, the probability of an extension of the cycle has increased, as the inflation figures in Brazil showed unfavorable dynamics even before the conflict, which tends to worsen.
On Brazilian stock exchange B3, the digital options market indicated, on Friday afternoon, a 66% chance of a 100 bp increase in the Selic in March. This possibility, however, has already reached more than 90%. In addition, the market has now built in higher odds of a 125 bp increase (20%) and a 150 bp increase (15%).
“In our view, even with a scenario of more perennial shocks, the Central Bank has a more limited total budget to raise interest rates, given the advanced stage of the cycle,” assesses Mirella Hirakawa, senior economist at AZ Quest. “It makes sense to go as planned and reduce the dose of adjustment.”
Although also pointing to a slowdown in pace, chief economist at Panamby Capital, Tatiana Pinheiro, notes that a good part of the factors advocates in favor of maintaining it. “Inflation surprised upwards; expectations continued to be revised upwards; commodity prices in reais also increased despite the appreciation of the real; even economic activity came in a little better than expected… These are indicators that go in the opposite direction of a reduction in the pace of adjustment.”
A focus for investors’ attention, in the current environment of high uncertainty, will be what the Copom will signal for the next steps. There are those who believe that it would be more prudent for the committee to anticipate a further deceleration of pace for the May meeting. This is the case of Fernando Honorato, chief economist at Bradesco, for whom the Central Bank should re-emphasize, as in the last meeting, the lag in monetary policy and also give weight to the transitory aspect of the shock in the balance of inflation risks.
“The Central Bank’s reference scenario projections will change significantly, but it has to assume some reversal of the commodity shock by the end of 2023, which is the horizon it is looking at. If not, we will be thinking about Selic levels above 13%, eventually, and that would involve a very big sacrifice for the activity”, evaluates Mr. Honorato. Last week, Bradesco increased its Selic forecast at the end of the cycle to 12.75% from 11.75%, but the economist expects more moderate interest rate adjustments ahead so that there is time for the Copom to observe the effects on economy.
In addition, he says that the Central Bank should emphasize the fight against the secondary effects of a classic supply shock like the current one. “If it doesn’t do that, the monetary authority will give the impression that it wants to endogenize an external supply shock, which is like saying it intends to fully combat this local effect of global inflation. It actually makes more sense to emphasize combating secondary shocks.”
For Mr. Hirakawa, with AZ Quest, what remains for the Central Bank “is to slow down the pace while maintaining the hawkish tone for the next meetings. “The Copom has to remain vigilant, but it must lengthen the cycle with more moderate doses of tightening because inflation expectations for 2023, lower than those for 2022, will become its exclusive focus after this week’s meeting,” she says.
At the other end, UBS BB started to project an increase of 150 bp and a Selic of 13.75%, in view of the increase in commodity and energy prices, which should make inflation this year and in 2023 higher than previously expected and lead to a slower normalization of relative prices. Thus, it is of “extreme importance” that no central bank, in particular the Brazilian one, allows inflation expectations to move upwards, at the risk of losing control, economists point out in a note to clients.
Source: Valor International