Analysis: Central Bank’s inflation scenario affected by economic slack

In practice, this reflects stronger GDP expansion and lower-than-expected unemployment rate


Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

It was not only supply shocks and other surprises that made the Central Bank revise upwards its inflation projections. There were also the impacts of the lower-than-estimated degree of economic slack and the higher neutral interest rate, according to the Inflation Report released by the monetary authority Thursday.

Since March, the Central Bank increased its inflation projection for 2022 by 2.5 percentage points to 8.8%. A good part of this increase is due to the war in Ukraine, which has caused the prices of oil and other commodities to surge and disrupted production chains due to China’s zero Covid policy.

But the revision in the inflation projections, to some extent, is due to the fact that the Central Bank overestimated the degree of economic slack at the beginning of the year.

In March, the monetary authority had estimated that the so-called output gap, a measure of the economic slack, would be 1.8% at the end of the first quarter. Thursday’s Inflation Report redoes this calculation and finds that, in fact, the slack was 1.1%.

From the point of view of the real sector of the economy, this is good news. In practice, it reflects stronger GDP expansion and a lower-than-expected unemployment rate. The Central Bank has increased its estimate for GDP in 2022 to 1.7% from 1%. But on the other hand, this means that economic slack has not been as strong a driver of lower inflation as expected.

In the second quarter, another surprise: the Central Bank estimated the economic slack at 2%, but according to the most recent estimate in Thursday’s report, it has been revised downwards to 1.3%. A good part of the consequences of this lower-than-expected slack is still expected to reach inflation, which reflects the output gap with a few quarters of delay.

Economic activity was stronger than expected, in part due to the reopening of the economy with vaccination and a lower number of deaths from Covid. But GDP data for earlier this year also reflect last year’s still expansionary monetary policy and fiscal expansion measures.

Another factor that contributed to increasing Central Bank’s inflation projections was the revision of the neutral interest rate. In its June meeting, the Central Bank’s Monetary Policy Committee (Copom) increased its view on the neutral interest rate to 4% from 3.5%.

The market had already revised its estimates to 4% by the end of 2021, due to the high fiscal risk amid tax-cutting measures and spending expansion during the election. But the Central Bank made the move in two stages, raising it to 3.5% from 3% in December, and now to 4%.

A consequence of this is that the economy has seen, before the revision of the neutral rate, a monetary tightening lower than the one estimated by the Central Bank. The monetary tightening represents the difference between the real interest rates forecast by the market and the neutral interest rate.

In Thursday’s Inflation Report, the Copom says that the monetary tightening is lower than previously estimated, in March, until the first half of 2023, precisely because the neutral rate has risen. The tightening is higher in the second half of 2023, because the market now expects a higher Selic policy interest rate for the period.

In practical terms, this higher neutral interest rate leads to a higher inflation projection not only for 2022, but also for next year, which is the relevant horizon for monetary policy. The Central Bank has revised its inflation projection for 2023 by 0.9 percentage points, to 4%.

The Inflation Report says that other factors have also contributed to the rise in projected inflation this year, such as rising inertia and deteriorating inflation expectations. Inertia and expectations, in turn, may have been affected by inflationary surprises and higher price indexes in the short term. But they are also determined by the degree of monetary tightening and the level of economic slack, as well as fiscal uncertainty.

*By Alex Ribeiro — São Paulo

Source: Valor International

Analysis: Central Bank mulls keeping high interest rates for longer

Policymakers seem to hope that situation will improve to the point of making additional hike unnecessary


Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

Central Bank’s Monetary Policy Committee (Copom) is now considering the possibility of maintaining interest rates at a high level for longer to meet the inflation target. This would complement or replace the previous strategy of raising the Selic, Brazil’s benchmark interest rate, to even higher levels in the final leg of the monetary tightening cycle.

In the minutes of last week’s meeting unveiled Tuesday, the policymakers say they analyzed this possibility. They have also discussed which message to send about monetary policy for the next meeting, to be held in August.

As the inflation environment has deteriorated, the Copom decided that it was about time to raise the interest rate even more last week, to 13.25% a year from 12.75% a year. The policymakers have also signaled that they will keep interest rates at a high level for longer than the markets have been expecting in order to complement the necessary tightening dose. “The strategy of convergence around the target requires a more contractionary interest rate than that used in the reference scenario for the entire relevant horizon,” the minutes say.

In last week’s meeting, the reference scenario provided for an interest rate of 13.25% at the end of 2022, 10% at the end of 2023 and 8.5% at the end of 2024. This way, considering what the minutes say, the Copom seemingly believes that the interest rates must be above each of these percentages at the end of each year.

The minutes could not make it clear how a higher interest rate at the end of 2023 or 2024 will help to meet the inflation target on the relevant horizon, which is 18 months ahead. The interest rates in 2023 will impact inflation more in 2024 than in the current monetary policy horizon.

The alternatives between raising the interest rate to a higher level now or keeping the rate higher for longer were also analyzed when the Copom discussed future monetary policy signals for the next meeting, in August.

Here again, the Copom concluded that keeping interest rates high for longer will not be enough to meet the inflation target. As a result, the chosen strategy was to signal a 50-basis-points hike or a 25-basis-points hike, depending on the inflation rates until there.

In a very important point to consider regarding future signals of monetary policy, the Copom said the perspective of maintaining the Selic rate for a sufficiently long period would not assure, “at this moment,” the convergence of inflation around the target in the relevant horizon.

It has been a while since the Copom used this phrase when talking about future steps – the intention, historically, has been to highlight that any signal is reliant on the evolution of the economic scenario. If the committee considered it better to include the expression “at this moment” now, it probably sees chances of positive evolution of this scenario by August, in a way that allows meeting the target by only keeping the interest rates at the current level, of 13.25% a year.

On the other hand, the Central Bank made a point of reinforcing, as it had already done in May, that the outlook is very uncertain, so it requires caution. When they presented their inflation projections, the policymakers said that uncertainty “has increased since the previous meeting.” Caution, in this case, is related to the risk of setting a higher-than-necessary dose of interest rate.

The debate about the Copom’s decision started with the directors saying they have already done a lot. “It was emphasized that the current monetary tightening cycle was quite intense and timely and that, due to monetary policy lags, much of the expected contractionary effect and its impact on current inflation are still to be seen.”

All things considered, the Copom is moving to stop raising interest rates and to keep them high for a sufficiently long period. It signaled a new hike for August, but it seems to hope that the situation will improve to the point of making an additional hike unnecessary.

Will the Central Bank be able to stop raising the interest rates? The Copom has been signaling the end of the cycle since March, but it was not possible. This time, the policymakers decided to keep raising the rates because the “Copom observed deterioration in both the short-term inflationary dynamics and the longer-term projections.” The reaction function still seems to be in place: if more negative surprises come, the Central Bank will keep raising the interest rates.

*By Alex Ribeiro — São Paulo

Source: Valor International

Analysis: Should Central Bank reassess fiscal risks?

Questions emerged after federal government’s decision to undermine fiscal anchor to hold fuel prices down


Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Market analysts have begun to discuss whether the Central Bank’s Monetary Policy Committee (Copom) should reassess its balance of risks to inflation after the government unveiled the intention to go over the spending cap to reduce fuel prices in this election year.

In its last two meetings, the Copom became less downbeat about the fiscal situation. As a result, the danger that the lack of control of public accounts could lead to higher inflation than projected for next year took a back seat in its monetary policy decisions.

In March, the policymakers concluded that the balance of risks to inflation was less tilted to the negative side, arguing that current fiscal data were better than expected and that the foreign exchange rate and inflation expectations already reflect most risks. In May, for similar reasons, they saw risks balanced.

The rebalancing of risks was at odds with the view of most of the market. The pre-Copom survey made on the eve of the meeting in March showed that 50% of economic analysts evaluated that the fiscal situation had worsened at that moment, compared with 22% who said it had improved. The remaining 28% thought there had been no change.

Due to the strike by Central Bank employees, the results of the May pre-Copom survey were not released. The Central Bank has sent a new survey to the market to gauge opinions for its meeting next week.

In its official documents, the Central Bank has asked the financial market for “serenity” in assessing fiscal risks in an environment it considers to be one of great uncertainty. Many, however, say that the improvement in short-term data is undermined by the destruction of the fiscal anchor.

The exchange rate is again under pressure as the deterioration of the fiscal situation became clear after a new attempt by the federal government to go over the spending cap, the rule that limits public spending to the previous year’s inflation. Above all, such deterioration caused long-term interest rates to rise, which means that investors require a higher premium to buy National Treasury bonds.

A potential revision of the balance of risks would have implications for monetary policy. Currently, the Copom is managing interest rates with a view to meeting the 2023 inflation target. According to the most recent projection of the monetary authority, released in the May meeting, inflation is seen at 3.4% in 2023, above the 3.25% target for the year.

The market, however, already estimates inflation of 4.39% in 2023, after faster rates in April and May. The projections by the Central Bank may be revised upward as well.

If the Central Bank acknowledges the worsening of the balance of risks, making it asymmetric again, it would mean that the inflation expected by the policymakers would be even higher, since the chances of a higher-than-expected reading would be greater than of a lower-than-expected rate.

In theory, this would require even higher interest rates to bring inflation to the target within the relevant monetary policy horizon.

But many analysts are skeptical that the Central Bank will revise its balance of risks to inflation. The monetary authority has sent several messages that it is near the end of the monetary tightening cycle. In addition, considering that current inflation is rising more than expected, the Central Bank is unlikely to look for new reasons to raise interest rates even more.

* Alex Ribeiro — São Paulo

Source: Valor International

Reversal of monetary tightening depends on data, Central Bank says

Bruno Serra — Foto: Carol Carquejeiro/Valor

Bruno Serra — Foto: Carol Carquejeiro/Valor

Bruno Serra Fernandes, the Central Bank’s director of monetary policy, said Wednesday that the outlook is becoming more positive for inflation, but does not yet allow one to glimpse the beginning of the reversal of the monetary tightening cycle. According to him, the cycle seems to be coming to an end, but decisions depend on the trajectory of data.

“Looking ahead, I think we start to have more positive inflation, hopefully before the peers. But thinking about easing monetary policy is a step that lies ahead. We first need to see the effect of what we have done,” he said at an event in São Paulo.

Mr. Serra added that the cycle seems to be coming to an end, but that if reality imposes a more negative scenario, the monetary authority may extend it a little further.

This month, the Central Bank raised the Selic, Brazil’s benchmark interest rate, by 100 basis points, to 12.75% per year, and said that it sees “as probable” a new, smaller hike in June. In the minutes of the meeting that raised the rate, the directors reinforced their bet on the lagged effects of monetary policy to bring inflation and expectations to the target in 2023.

Financial market analysts see chances of the Central Bank adopting the strategy of high interest rates for a long time to combat the most recent inflationary pressures, instead of taking the Selic much higher than the current level. On Monday, Mr. Serra said that the Central Bank tries to avoid rate fluctuations, although it doesn’t always succeed.

On Wednesday, the director stressed that the effects of the interest rate hike are not yet fully tangible. He recalled that the tightening cycle was made in an intense and fast way, but that, until the second half of last year, the monetary policy was still stimulating the economy. And he said again that from the second half onwards the effects of the tightening will be clearer, here and abroad.

Mr. Serra emphasized the challenging international backdrop but said that he believes that central banks are working and equipped to bring inflation back to the target. For him, the U.S. Federal Reserve and other developed country central banks have “gotten into the game” to deal with global surplus demand.

Mr. Serra stressed that to conduct local monetary policy, it is key that global inflation moves toward about 2%, and that above that it is possible that the models will not work as well. He added, however, that he believes that the central banks are pursuing their targets.

Asked about fiscal pressures in the country, especially in an election year, he said that at the moment the spending cap, the rule that limits growth in public spending to the previous year’s inflation, is being attacked from “all sides” but that, from November on, it will be necessary to make clear the existence of an instrument that indicates the country’s fiscal direction.

“Right now, many people are attacking the cap, but I think that soon it will become clear that, whether it is the cap or something slightly different, we will need some fiscal target that addresses the situation, that reduces the fiscal uncertainty that weighs on asset prices,” he said.

Source: Valor International

Analysis: Central Bank avoids new hints amid unchecked inflation

Central Bank building — Foto: Jorge William/Agência O Globo

Central Bank building — Foto: Jorge William/Agência O Globo

In an environment that is more uncertain than usual, the Central Bank’s Monetary Policy Committee (Copom) has chosen, in the minutes of last week’s meeting released on Tuesday, to describe in more detail how it sees this scenario, instead of signaling what its next steps could be. Even if the policymakers look to a longer horizon and adopt a cautious stance, the deterioration in the inflationary picture is likely to continue in the short term.

Last week, the Copom raised the benchmark interest rate to 12.75% per year from 11.75%. In the minutes in which it detailed the reasons for the decision, the committee invested in a section, much broader than the previous one, called “scenarios and risk analysis.” There, the Central Bank discusses risks that range from the war in Ukraine to the “Chinese policy to fight Covid-19” to the “persistently high demand for goods,” including in the United States. The policymakers also acknowledged that they discussed in the meeting “some likely explanations for the difference between the projection in its reference scenario [of the Central Bank] and the analysts’ projections” – a point that has been drawing the market’s attention for some time. Perhaps even more indicative is the fact that it has included the baseline inflation scenario in the section dealing with risks. In March, for example, this scenario was presented in the section that dealt with the economic situation. In other words: the main pillar on which the Copom relies to make its decisions about the Selic has lost reliability to some degree.

“The Committee judges that the uncertainty in its assumptions and projections is higher than usual,” it said on Tuesday regarding the baseline scenario.

In the opposite direction, the section that addresses the discussion about the conduct of monetary policy was much leaner in Tuesday’s minutes. The Copom affirmed that it opted “to signal as likely an extension of the cycle, with an adjustment of lower magnitude [than 100 basis points] in the next meeting.” But it said it decided on this signal, among other factors, since it “reinforces the cautious monetary policy stance and emphasizes the uncertain scenario.”

This does not mean that inflation will not get worse in the short term. In the Quarterly Inflation Report, a comprehensive document that details its assessment of the economic situation, the Central Bank projected that the Extended Consumer Price Index (IPCA) would be 1.02% in March – but the actual rate was higher, of 1.62%. Central Bank President Roberto Campos Neto acknowledged he was surprised by the reading.

April’s IPCA-15, a barometer for Brazil’s full month official inflation, continued to show deterioration, rising 1.73%. It was the highest level for April since 1995 and the also highest monthly rise since February 2003. As a result, the 12-month inflation rose to 12.03% in April from 10.79% in March. Besides the high readings, analysts have drawn attention to negative data, including qualitative aspects of inflation such as the diffusion index, which measures the number of products whose prices rose during the month. In Apex Capital’s calculations, the indicator reached 76% in April’s IPCA-15, the highest in almost 20 years.

To steer the Selic, Brazil’s benchmark interest rate, the monetary authority is currently aiming at 2023, for which the inflation target is 3.25%, with a tolerance interval of plus or minus 1.5 percentage points. But such a high and widespread inflation makes it difficult to bring the trajectory of prices to this target. As Valor reported Tuesday, inflation expectations have been deteriorating, both in the case of implicit projections in government bonds and in the estimates made by financial firms, consultancies and asset managers. Some firms project inflation of around 10% for this year. The Central Bank’s baseline scenario projections are 7.3% and 3.4% for 2022 and 2023, respectively. It is worth mentioning, also considering long-term inflation, the 8.87% adjustment made Monday by Petrobras in the price of diesel at the pump, which has a broad impact on the production chain.

In Tuesday’s minutes, the Copom acknowledges that the situation is serious, stating that “consumer inflation remains high, with increases spread among several components, and continues to be more persistent than anticipated.”

“Whereas inflation of services and industrial goods are still high, the recent shocks have led to a strong increase in the components associated with food and fuels. Recent readings were higher than expected, and the surprise came on both the more volatile components and the items associated with core inflation,” the Copom said. “As for the more volatile components, the increase of gasoline prices is still noteworthy, with greater and faster impact than anticipated. The inflation of the components more sensitive to the economic cycle and the monetary policy continues elevated, and the various measures of core inflation are above the range compatible with meeting the inflation target.”

The format of the minutes’ wording may have changed, in part, because of the presence of Central Bank’s new director of economic policy, Diogo Guillen, appointed at the end of April. But it is hard to deny that, in the face of such external and internal uncertainties, the monetary authority has been opting for a more cautious stance since last week. It is also clear that the inflationary environment continues to worsen in the short term.

Source: Valor International

Inflation expectations put pressure on Central Bank

The challenge of inflation, which was already a tough one, has become even more arduous. Inflation medium-term expectations are increasingly unanchored considering projections of market economists and the inflation priced into financial assets. The consequence is clear in the behavior of the interest rate market, which has come under pressure amid the perspective of even higher rates for a long period of time.

Strong swings in the rates of the NTN-Bs, the government bonds pegged to Brazil’s official inflation index IPCA, shows a worsened perception of inflationary risk ahead. The inflation priced by NTN-Bs maturing in August is close to 9% — it reached 8.73% on Friday. Expectations seem to be increasingly unanchored even for those with longer maturities. The inflation priced by the NTN-B maturing in August 2050, which started the year at 5.19%, reached, at the end of last week, 6.39%.

“The market has been pricing the gasoline lag in recent days. People start to account for the impact of the adjustment on fuel prices and its side effects. From there, they start to include inflation premiums in the curve,” said Pedro Nunes, ACE Capital’s fixed income manager, when justifying the strong upward movement of inflationary expectations in the market. On Monday, Petrobras unveiled an 8.8% adjustment in diesel prices at the refineries but kept gasoline prices unchanged.

The strong rise in fuel prices abroad also helps explain the recent advance of the breakeven inflation, said Maurício Patini, Brazil interest rate manager at Absolute Investimentos. He added that the current inflation data for the first quarter of the year also help explain the rise in market inflation, since they are higher than expected.

According to Mr. Patini, this generates more revisions due to the high correlation with a large part of regulated prices “and shows that the Central Bank’s job has become more difficult, given that inflation is widespread.”

Not coincidentally, interest rate futures have been under considerable pressure in recent days, as the market begins to see more clearly the Selic, Brazil’s benchmark interest rate, at an even higher level for a longer period. “People have the end of the cycle in their minds, but we believe that since inflation is rising, it is difficult for the Central Bank to indicate that it will stop. It is a very big risk. We think that a 50-basis-point hike in the next meeting is the floor,” said Mr. Nunes, with ACE Capital.

For him, the likely adjustment in gasoline prices and a still very pressured external inflation show how difficult Central Bank’s job is now. “I think it is very risky for the Central Bank, as the policymaker, not to keep inflation in check and then be forced to raise interest rates again later on. He can’t take that risk. That is why we think the Central Bank could end up raising interest rates a little more,” Mr. Nunes said.

The concern regarding an even more challenging inflation is also materialized in the projections of market economists. Last week, J.P. Morgan raised its projection for the IPCA in 2022 to 9.1% from 8%; Safra increased its estimate to 8.1% from 7.3%; Itaú Unibanco now sees the IPCA at 8.5%, and no longer at 7.5%; Banco do Brasil raised its projection to 8.5% from 7.8%; and BNP Paribas now expects inflation to end the year at 10%, and no longer at 8.5%.

Part of the recent worsening of expectations reflects agricultural supply shocks; the proximity of the summer in the United States., which is likely to increase demand for diesel; and the possibility of European sanctions on Russian oil. “We are very likely to experience a period of major supply shortages in the next two, three months,” said Carlos Thadeu Freitas Gomes Filho, a senior economist at Asset 1. His concern is translated into a projected IPCA of 9.5% in 2022, with chances of reaching 10% with the gasoline adjustment, and 5% in 2023.

In BTG Pactual Asset Management’s macroeconomic scenario review, economist Stefanie Birman reveals that the firm now projects inflation rates of 9.7% this year and 6% in 2023. “We saw a broader rise in expectations,” she said. Ms. Birman also pointed out that, regarding the IPCA in the short term, BTG Asset expects that, in the March-May period, the IPCA will be 1 percentage point higher than the Central Bank’s projected in the March Inflation Report. Then, the monetary authority estimated that the IPCA between March and May would be 2.1%.

Paulo Val — Foto: Leo Pinheiro/Valor
Paulo Val — Foto: Leo Pinheiro/Valor

The prospect of higher, resilient global inflation is increasingly present in the composition of scenarios, said Paulo Val, chief economist at Occam. “Without a doubt, it will be challenging for our Central Bank. In the past decade and the decade before, global inflation was a disinflation drive for us, and that is an important thing that has changed,” he said. Occam projects the IPCA at 8.4% this year and at 4.6% next year, with an upward bias on both forecasts.

Mr. Val expects another 50-basis-point hike in the Selic in June, to 13.25%. Then, according to him, the Central Bank is likely to wait the elections to evaluate what the new fiscal policy will be. “If they are consolidation policies, that really control spending more clearly and society perceives it that way, I think it eases monetary policy a little bit.”

The fact that inflation has been above the center of the target since the end of 2020 and above the top of the target range since the beginning of 2021 weighs on the longer horizon, Mr. Val said. “It’s a long period already.”

In addition, fiscal policy can be a big question mark in perspectives. “You have this uncertainty about what the fiscal framework will be starting next year, regardless of who wins the elections. This fans inflation,” he said. Besides this and the external challenges already mentioned, there is the fact that emerging countries have a more chronic inflation problem, Mr. Val said. “This whole environment of uncertainty around inflation generates demand for more premium, even over longer horizons.”

Source: Valor International

Central Bank raises interest rate by 100 bp, to 12.75%

Policymakers also affirmed that the future steps of the monetary policy may be adjusted to ensure the convergence of inflation to its targets — Foto: Beto Nociti/BCB
Policymakers also affirmed that the future steps of the monetary policy may be adjusted to ensure the convergence of inflation to its targets — Foto: Beto Nociti/BCB

The Central Bank’s Monetary Policy Committee (Copom) raised the policy interest Selic rate by 100 basis points and signaled an extension of the monetary tightening cycle for its next meeting. “For its next meeting, the Committee foresees as likely an extension of the cycle, with an adjustment of lower magnitude,” the Central Bank said in a note. The Copom raised the benchmark interest rate to 12.75% a year from 11.75%.

According to the document, the committee notes that “heightened uncertainty of the current scenario, the advanced stage of the current monetary policy cycle, and its impacts yet to be observed require additional caution in its actions.”

The policymakers also affirmed that the future steps of the monetary policy may be adjusted to ensure the convergence of inflation to its targets “and will depend on the evolution of economic activity, the balance of risks and inflation expectations and projections for the relevant horizon of monetary policy.”

In its decision, Copom maintained its assessment that risks exist in both directions for inflation and highlighted the persistence of global inflationary pressures and uncertainty regarding the future of the country’s fiscal framework among the factors that would push prices upwards.

On the other hand, a possible reversal, even if only partial, of the increase in commodity prices in reais and a sharper-than-projected slowdown in economic activity could impact the price index in the opposite direction.

In the March meeting, the Central Bank had outlined two scenarios for oil. Wednesday, the monetary authority opted for keeping the alternative scenario as the main one — in it, the barrel ends this year at $100 and increases 2% a year starting in January 2023.

The Copom also evaluated that the external environment continued to deteriorate. “Inflationary pressures arising from the pandemic period have intensified due to supply problems related to the new wave of Covid-19 in China and the war in Ukraine. The repricing of monetary policy in advanced countries increases uncertainty and generates additional volatility, particularly in emerging countries,” it said. In relation to the Brazilian economic activity, the monetary authority stated that growth is in line with what was expected.

The Copom reiterated that consumer inflation continued to surprise negatively. “These surprises occurred both in the more volatile components and on the items associated with core inflation,” it pointed out.

Read the English version of Copom’s full statement distributed by the Central Bank:

In its 246th meeting, the Copom unanimously decided to increase the Selic rate to 12.75% p.a.

The following observations provide an update of the Copom’s scenario:

The global environment has deteriorated further. Inflationary pressures arising from the pandemic period have intensified due to supply problems related to the new wave of Covid-19 in China and the war in Ukraine. The repricing of monetary policy in advanced countries increases uncertainty and generates additional volatility, particularly in emerging economies;

Turning to the Brazilian economy, the set of indicators released since the previous Copom meeting suggests a rate of growth in line with the Committee’s expectations;

Consumer inflation continued to surprise negatively. These surprises occurred both in the more volatile components and on the items associated with core inflation;

The various measures of underlying inflation are above the range compatible with meeting the inflation target;

Inflation expectations for 2022 and 2023 collected by the Focus survey are around 7.9%, and 4.1%, respectively; and

In the reference scenario, the interest rate path is extracted from the Focus survey, and the exchange rate starts at USD/BRL 4.95* and evolves according to the purchasing power parity (PPP). The Committee decided to keep the assumption that oil prices follow approximately the futures market curve until the end of 2022, ending the year at USD 100/barrel, and then start increasing 2% per year in January 2023. The energy flag is assumed to be “yellow” in December of 2022 and 2023. In this scenario, Copom’s inflation projections stand at 7.3% for 2022 and 3.4% for 2023. Inflation projections for administered prices are 6.4% for 2022 and 5.7% for 2023. The Committee judges that the uncertainty in its assumptions and projections is higher than usual.

The Committee emphasizes that risks to its scenarios remain in both directions. Among the upside risks for the inflationary scenario and inflation expectations, it should be emphasized (i) a greater persistence of global inflationary pressures; and (ii) an increase in the risk premium due to the uncertainty about the country’s future fiscal framework, partially incorporated in inflation expectations and asset prices. Among the downside risks, it should be noted (i) a possible reversion, even if partial, of the increase in the price of international commodities measured in local currency; and (ii) a greater deceleration of economic activity than projected. The Committee assesses that the uncertain and volatile current scenario requires serenity when evaluating the risks.

Taking into account the assessed scenarios, the balance of risks, and the broad array of available information, the Copom unanimously decided to increase the Selic rate by 1.00 p.p. to 12.75% p.a. The Committee judges that this decision reflects the uncertainty around its scenarios for prospective inflation, an even higher-than-usual variance in the balance of risks and is consistent with the convergence of inflation to its target throughout the relevant horizon for monetary policy, which includes 2023. Without compromising its fundamental objective of ensuring price stability, this decision also implies smoothing of economic fluctuations and fosters full employment.

The Committee considers that, given its inflation projections and the risk of a deanchoring of long-term expectations, it is appropriate to continue advancing in the process of monetary tightening significantly into even more restrictive territory. The Committee emphasizes that it will persist in its strategy until the disinflation process consolidates and anchors expectations around its targets.

For its next meeting, the Committee foresees as likely an extension of the cycle, with an adjustment of lower magnitude. The Committee stresses that the heightened uncertainty of the current scenario, the advanced stage of the current monetary policy cycle, and its impacts yet to be observed require additional caution in its actions. The Copom emphasizes that its future policy steps could be adjusted to ensure the convergence of inflation towards its targets and will depend on the evolution of economic activity, the balance of risks, and inflation expectations and projections for the relevant horizon for monetary policy.

The following members of the Committee voted for this decision: Roberto de Oliveira Campos Neto (Governor), Bruno Serra Fernandes, Carolina de Assis Barros, Diogo Abry Guillen, Fernanda Magalhães Rumenos Guardado, Maurício Costa de Moura, Otávio Ribeiro Damaso, Paulo Sérgio Neves de Souza and Renato Dias de Brito Gomes.

*Value obtained according to the usual procedure of rounding the average USD/BRL exchange rate observed on the five business days ending on the last day of the week before the Copom meeting.

Note: This press release represents the Copom’s best effort to provide an English version of its policy statement. In case of any inconsistency, the original version in Portuguese prevails.

Source: Valor International

Itaú Asset sees Central Bank close to ending tightening cycle

Thomas Wu — Foto: Silvia Zamboni/Valor

Thomas Wu — Foto: Silvia Zamboni/Valor

The strategy by the Brazilian Central Bank that prioritizes keeping the Selic at a level around 13% for longer instead of raising the benchmark interest rate to even tighter levels is valid. Thomas Wu, the chief economist at Itaú Asset, believes that it is preferable that monetary policy “be a marathon, not a 100-meter dash,” considering the current interest rate.

In line with the market, Mr. Wu projects a hike of 100 basis points in the Selic rate in Wednesday’s Monetary Policy Committee (Copom) announcement, and another one of 50 basis points in June, taking the rate to 13.25% at the end of the cycle. “Maybe it can go up in August, but 50 basis points more will not change the entire strategy. The Central Bank is very close to stopping,” said the economist, who has already worked at Verde Asset and was a professor at the University of California, Santa Cruz.

In an interview with Valor, his first since he joined Itaú Asset in January, Mr. Wu points out that raising interest rates to a much more restrictive level may not be advantageous to bring inflation to the target in 2023 if this hinders the more general notion of well-being that it ultimately should represent. “What it [the Central Bank] needs to make very clear is that it will only cut interest rates when inflation starts to fall,” Mr. Wu said, acknowledging that the choice “for consistency” brings challenges. Read the interview below.

Valor: The Central Bank started to indicate in March that it wants to end the cycle of interest rate hikes. How do you see this strategy?

Thomas Wu: Any problem has three variables: its size, the dose of the medicine and the duration of the treatment. The interest rate is already restrictive, our neutral rate is not at double-digit levels, although the way we estimate the neutral real interest rate is somewhat vague. If we look at the 360-day nominal interest rate and subtract the 12-month inflation expectation showed by the Central Bank’s Focus bulletin and the neutral rate estimated by the monetary authority, we have tightening similar to that of 2015 and 2016. How big is the problem? Each month we find that the gap between inflation and the target is wider. The Central Bank, then, could set a fixed relevant horizon and, if it finds that the problem is bigger, increase the dose of the medicine and go to [a Selic of] 14%, 15%, 16%. Or, as a central bank, it also has the right to do something else. If it suspects that the dose of the medicine is starting to cause more side effects, it can think that it has already reached the size and extend the horizon. It will get there, but will take longer.

Valor: Is the Central Bank close, then, to ending the cycle?

Mr. Wu: As a strategy, the Central Bank is very close to ending. He may give 100 basis points next time and maybe 50 basis points in June. Maybe it can go up in August, but 50 basis points more will not change the entire strategy. In the estimation of models, the interest rate is already in the contractionary territory. It must make very clear that it will only cut interest rates when inflation starts to fall. It is a strategy for consistency, which does not raise the dose of medicine up high. Roughly speaking, I think it is valid, although it has its challenges. It is not easy.

Valor: What are these challenges?

Mr. Wu: To stop raising interest rates while underlying inflation is still on the rise. The statement has to be very well done and has to say that it is stopping [raising the Selic], but not because it is abandoning it. The risk of this strategy is that some people interpret that the Central Bank is not doing what it needs to do and that expectations become even more unanchored.

Valor: Inflation expectations for 2023 are already quite far away from the center of the target…

Mr. Wu: We are working with inflation above the target next year. We have 8.1% this year and 4.6% in 2023. Does this mean that we think the Central Bank will not do its job? Not at all. Inflation is a global problem. Inflation is high and accelerating around the world, and Brazil is one of the few countries where interest rates are in the contractionary territory. I don’t project inflation at the target next year because I don’t think it is necessary to put the interest rate at such a level that convergence happens in 2023. In my estimates, the rate needed for that would do more harm than good. You would anchor inflation, you would bring it to the target, but the target, in a general context, indicates more sustainable long-term growth. If you take this literally and raise interest rates to bring inflation to the target next year, maybe this more general concept of sustainable growth starts to lag further behind.

Valor: When would this convergence occur?

Mr. Wu: We have had several shocks around the world. Interest rates tackle the secondary effects. I think we are going to live for a long period with high inflation and above the target. It will take a long time for interest rates to drop. We are discussing some convergence in 2024. It is a matter of preference. Some economists will say that, unfortunately, for reasons of anchoring and credibility, there is no other way out than to take interest rates to 15%, 20%… This is also valid. I prefer it to be a marathon, not a 100-meter dash. It’s about persevering with an already contractionary dose of medicine, resisting all the pressures to cut and only start reducing interest rates when it is clear that the problem has been addressed. Starting an easing cycle at the end of next year is risky. The market has already priced it in at the turn of the year. I think it is a quite optimistic assumption, especially because we don’t know yet how big is the problem.

Valor: Major central banks around the world are also beginning to tighten their monetary policies. Doesn’t this help to contain some of this global inflation?

Mr. Wu: All central banks except Japan are saying that they are going to start doing some kind of monetary tightening, each one at a different timing of its cycle. Is a recession coming? I think it will come in the same way that we are sure that winter will come. It doesn’t mean that I am super pessimistic. But you can’t fight inflation without holding back aggregate demand. At the moment, the biggest problem is that inflation is still accelerating. A great part of it has to do with a very strong demand in the United States.

Valor: What is the asset manager’s projection for U.S. interest rates?

Mr. Wu: This terminal rate around 3% that appeared in the last FOMC meeting seems low to me. For a terminal rate to be in the contractionary territory in the U.S., the risk is for it to be above 4%.

Valor: And here in Brazil, do you see evidence of demand inflation?

Mr. Wu: We have a very high diffusion. The number of products at a high inflation rate is large, it goes beyond food. When you see something like that, you imagine it has a common demand component. Interest rates are at a contractionary level, consumer default rates are rising, but consumer spending is strong and I think it will take time to disinflate. As for the labor market, it is not wonderful, but it is resilient, it is not weakening.

Valor: Isn’t the interest rate tightening having any effect?

Mr. Wu: Like the whole market, we have been surprised by the strength of consumer spending. The question we asked ourselves was: Isn’t the interest rate in the contractionary territory? Or is the effect more delayed than usual? We concluded that it [the higher interest rate] will take longer to impact [the activity]. Corporate results are healthier. At the opposite end, individuals enter this cycle more leveraged – for a good reason, as more people have access to credit. On the other hand, we are experiencing a good moment in terms of how people feel about the pandemic, and there is pent-up demand when people are concerned. The authorization to withdraw money from Workers’ Severance Fund (FGTS) accounts and the anticipation of the 13th salary [a year-end bonus] also help the balance of households. This is why I have the perception that the Central Bank’s strategy to disinflate the economy has to be done with persistence. It will require patience, perseverance, discipline. But we also have to be humble; the moment is one of great uncertainty.

Valor: Is it the effect of this monetary policy ahead that justifies Itaú Asset’s projection for the GDP to go to 0.2% in 2023 from 0.8% in 2022?

Mr. Wu: Yes, with great uncertainty around, but we think that these effects will be greater in 2023. It is going to be a difficult year, because we are already going to feel the tightening of interest rates more strongly in activity, but I don’t know if underlying inflation is already giving clear signs that it is heading towards the target. We have 9.25% [of the Selic for 2023], but with an upward bias.

Valor: The exchange rate has become quite volatile again in the last few days. With which perspective do you work?

Mr. Wu: Looking at the Central Bank’s strategy of a tightening cycle that started in March of last year, to anchor inflation around 2024, the importance of the exchange rate in the model is not necessarily to find out the date of the Copom cut and see how much it gave. The Fed [U.S. Federal Reserve] started to become more hawkish about raising interest rates as of November [2021] and, in general, when a central bank as important as the American one becomes more aggressive, assets that are considered riskier lose value. The exchange rate suffers, but this is not what happened until very recently. It was a surprise, but now we can understand that one of the most relevant changes this year, after all these cyclical issues have passed, is that the world changed structurally at the beginning of 2022 with the conflict [in Ukraine]. Apart from the whole tragic issue, we focus on understanding what really changes with the end of the war and we realize that the relevance of Brazil and Brazilian assets in the world portfolios has increased. Structurally, I think Brazil will see more inflows over the next few years on average. Of course, there is a lot going on right now, like the lockdown in China, the Fed raising interest rates, the conflict. Looking at the end of this year, we had, until last week, more confidence that it would be a trajectory of appreciation [of the real against the dollar]. Now we are discussing four 50-basis point hikes, it is starting to get a little more tense, so there is a risk that this year will be bad, in a structural context in which the importance of Brazil has increased.

Source: Valor International

Analysis: Inflation projected for 2023 poses challenge to Central Bank

inflation expected by the market was 4%, well above the target set for the year, of 3.25% — Foto: Brenno Carvalho/Agência O Globo
inflation expected by the market was 4%, well above the target set for the year, of 3.25% — Foto: Brenno Carvalho/Agência O Globo

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

Analysis: Central Bank seeks to contain market reaction to inflation

Roberto Campos Neto — Foto: Reprodução/YouTube

Central Bank President Roberto Campos Neto downplayed concerns about the sharp acceleration in March inflation, seeking to contain the market’s reaction to the latest reading of the IPCA, Brazil’s official inflation index, unveiled Friday. Inflation was up 1.62% in the month, above the median of 41 projections compiled by Valor Data, of 1.32%.

The financial market followed Monday morning a live-streamed event with Mr. Campos Neto, held by Arko Advice and the Traders Club (TC), in search of signs about a possible extension of the monetary tightening cycle after the news on inflation.

Mr. Campos Neto said that the reading represents a “small” surprise, before explaining that the Central Bank needs to better analyze the data before unveiling its findings.

The central banker had been saying he saw a final interest rate hike in May, to 12.75% per year from the current 11.75%, as the more likely outcome. He did not repeat this message on Monday. But this seemingly does not mean he will tighten further, as he had already failed to repeat the signal in a statement at another event last Thursday, before the latest figure for the IPCA was released.

Mr. Campos Neto tried to soften the bad news in several moments. He said the monetary authority had already been calling attention to the fact that when oil company Petrobras raises fuel prices, the increases hit the pumps more quickly, although in the end the pass-through occurred at an even faster speed. According to him, this faster pass-through in a month means that, in the subsequent period, there will be compensation.

Mr. Campos Neto also said that it wasn’t only in Brazil that there were surprises in the most recent inflation reading, as several other countries faced the same situation. He highlighted the role that the recent appreciation of the real against the dollar may have in avoiding a strong impact of the rise in commodity prices in inflation.

According to him, the stronger real is not completely priced by the financial market, since many analysts are still working with a foreign exchange rate between R$5.25 and R$5.35 to the dollar. “When I look at the estimates I get from the inflation market, some people have already fully considered the [new] exchange rate, while others haven’t yet,” he said.

In other words, Mr. Campos Neto highlighted the exchange rate as a positive factor that could affect the market’s inflation expectations, at a moment when economic analysts are raising their projections in response to faster inflation.

And Mr. Campos Neto also said he was comfortable with the appreciation of the real, saying that it doesn’t demand interventions from the Central Bank. He signaled that he might start selling dollars on the market if there are impacts from the withdrawal of stimulus in the United States.

Mr. Campos Neto was asked if there was any special concern with services inflation. He answered that these prices had been showing the expected behavior during the reopening of the economy. But industrial goods prices failed to drop as expected. “[Service] inflation somewhat reacted in the way we expected,” Mr. Campos Neto said.

Some negative things mentioned by Mr. Campos Neto deserve attention. For example, he cited rising wages for the first time and spoke of high core inflation and the prices of clothing and food away from home, which showed a “surprising increase.”

But overall, he was quite careful to avoid definitive conclusions, claiming more than once that one must carefully study the data. He also recalled that the interest rate hikes made since last year have not yet had time to be seen in the economy.

In other words, Mr. Campos Neto’s entire speech was designed to acknowledge that the IPCA was higher than expected, but that it is undecided whether an additional monetary policy response will be necessary.

Source: Valor International