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Central Bank cools expectations of rate cut in early 2023

Lack of consistency in inflation projections still worries asset managers

09/08/2022

The Central Bank has tried to cool expectations that it will start reducing Brazil’s key interest rate as early as the first quarter of 2023. The fact that short-term inflation slowed down and commodity prices went south in the international market was a determinant to bringing down future interest rates in the last few days. This backdrop paved the way for the market to price in the yield curve the key rate, known as Selic, below 13.75% per year as early as March 2023.

The rise in future rates on Tuesday partly eliminated this variation. Yet, some market participants still expect interest rate cuts early next year.

Central Bank President Roberto Campos Neto told the audience at an event held by Valor on Monday that the monetary authority is not thinking about lowering interest rates at this moment. He has also reinforced the message of the last meeting of the Monetary Policy Committee (Copom), in August, when the Central Bank indicated that it will analyze the need for raising the Selic once more. Mr. Campos Neto’s message was reinforced by Bruno Serra Fernandes, the bank’s monetary policy director, who showed concern on Tuesday about the de-anchoring of inflation expectations for 2024 – the median is 3.43%.

“The work of the Central Bank has already been done. It recognizes this and has signaled that, from now on, it must remain cautious in order to bring inflation expectations to the target. We agree. The Central Bank must remain cautious, but we also think that this stance will make inflation converge to the target,” said Gustavo Pessoa, a partner and fixed-income manager at Legacy Capital. The firm’s baseline scenario includes rate cuts starting in March 2023.

“Since inflation is just starting to slow down, the Central Bank doesn’t want to commit to cuts, but reality will weigh in. Inflation has started to give way strongly, and not only because of the government’s measures. And this lower inflation has left the real interest rate [ex-ante] close to 9%, a level that will be enough to make inflation converge to the target. This will allow the Central Bank to start cutting interest rates at some point,” Mr. Pessoa said.

In Legacy’s view, in March 2023 the monetary authority will look, in particular, at inflation for 2024 on the relevant horizon, whose expectation is today at 3.43%. “We expect expectations to anchor again and the median of 2024 projections to return to 3% by March. The Focus expectations will probably drop, given the Selic rate level. So it would be a natural path for the Central Bank to start cutting interest rates. We think this will happen as of March, and how fast interest rates will drop depends a lot on inflation dynamics here and abroad,” he said.

On Monday, the yield curve was pricing a cut of about 0.20 percentage points in March 2023 as the starting point for an easing cycle. After the market closed on Tuesday, there was a relevant repricing, and the market stopped betting on cuts in the first quarter of next year.

Alexandre de Ázara, the chief economist of UBS BB, believes that Mr. Campos Neto wants to combat expectations of a premature start to the easing cycle. “I believe he said that it is important to maintain interest rates flat for a while. In my view, the Central Bank doesn’t like to see the market price cuts in the first quarter and I think he wanted to fix that,” he said.

Mr. Ázara believes it is early to price a cut in the first quarter, but sees room for stronger cuts throughout next year, as of June. UBS BB projects that in 2023 the Central Bank will make four 100-basis-point cut in the Selic rate, starting in the second meeting of the second quarter, and a final 50-basis-point reduction in 2023. In addition, the bank expects the cycle to continue in 2024, with the Selic reaching 7.75%.

“This will help inflation to converge to the target in 2024. If it falls too slowly, inflation will not converge in 2024. If it falls too early, it will not converge in 2023,” said Mr. Ázara, whose projection for Brazil’s official inflation index IPCA next year is 4%, well below the market consensus of 5.27%.

Cooler commodity prices in the international market have been key for the downward variation in short-term interest rates in recent weeks. Brent oil prices, now close to $90, drew attention.

Jose Carlos Carvalho — Foto: Leo Pinheiro/Valor

Jose Carlos Carvalho — Foto: Leo Pinheiro/Valor

“For two and a half years, commodities put upward pressure on inflation. It was a headwind that is now changing a little into a tailwind. I think this factor hindered the Central Bank a lot, but now it can be helpful,” said José Carlos Carvalho, a partner and head of macroeconomics at Vinci Partners. Yet, he recalled that services inflation is still under pressure. “Activity is still strong and should remain that way, but commodity-related prices more than make up for the rise in services.”

Mr. Carvalho believes that the Central Bank closed the monetary tightening cycle with the Selic at 13.75% and has a downward trajectory of interest rates ahead, considering that the real interest rate in Brazil is between 7% and 8%. According to him, these are quite high levels, well above the natural rate of interest, which is around 4%. “With help from commodities and the time for monetary policy to make its effect, the cycle of Selic hikes is over. There is no reason for the Central Bank to deliver even higher interest rates,” he said.

The cycle of interest rate reduction is related to the new federal administration and its fiscal policy, the executive with Vinci said. “In the first quarter of 2023, the Central Bank will still want to understand the fiscal policy of the next administration. In the second quarter, if it is the right thing to do, it can start thinking about cutting interest rates,” Mr. Carvalho said.

The fiscal policy is precisely one point highlighted by Tomás Goulart, the chief economist of Novus Capital, to advocate the view that the key interest rate is unlikely to start being reduced at the beginning of next year. He also cited the level of interest rates in developed countries, especially in the United States.

“The fiscal anchor is the first condition for the Central Bank to start reducing the Selic. It must know what the fiscal anchor will look like in the next administration, given the fact that the spending cap has lost credibility,” he said, citing the rule created to limit growth in public spending to the previous year’s inflation, which was circumvented by the Bolsonaro administration. The monetary authority will only feel ready to start easing the Selic when it finds out which fiscal regime will prevail in Brazil, he said.

“And then, considering the legislative process, we still don’t know what the next administration will be and what will be proposed in terms of an anchor. There is no clarity at the moment. And the legislative process to replace the fiscal anchor and pass something in Congress that has credibility should take around six months, that is, it will be time-consuming,” he said. When assessing the necessary conditions for the Central Bank to start reducing the key interest rate, Mr. Goulart said that such a cycle may start in June or August 2023.

*By Victor Rezende, Gabriel Roca — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Inflation expectations for 2024 rise as market expects smaller rate cut

Economists are anticipating a more challenging scenario for the Central Bank to meet inflation targets

09/05/2022

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

Fuel tax cuts will remain in place next year, which lowered financial market inflation expectations for 2023 but did not prevent them to rise in 2024 – a year that is already entering the monetary policy radar.

And the market has begun to factor in fewer interest rate cuts next year, anticipating a more challenging scenario for the Central Bank to meet inflation targets.

The Central Bank’s Focus survey with analysts, released Monday morning, shows that the market’s median projection for inflation in 2023 has dropped to 5.27% from 5.3%. It is the third consecutive week of decline in market projections for inflation.

This drop may be linked to the fact that fuel tax cuts will remain in place next year, per the budget bill. The measure, which some market analysts had already priced in, has the potential to lower inflation by 0.6 percentage points next year.

But the measure could also have a negative effect in the longer term because it increases the fiscal risk. In fact, the market’s median inflation forecast for 2024 increased again this week, to 3.43% from 3.41%.

The deterioration in inflation expectations for 2024 is of particular concern because the Central Bank has lengthened the time frame in which it intends to bring inflation to the target. Today, the Central Bank manipulates interest rates with a view to bringing inflation to the target in the first quarter of 2024.

The Central Bank has signaled that it is reaching the end of the monetary tightening cycle. But some analysts believe, according to the Focus survey, that the Central Bank will have to tighten the key interest rate Selic more, or at least postpone interest rate cuts.

The distribution of expectations about interest rates, released Monday by the Central Bank, shows that 80% of analysts think that the monetary authority will leave interest rates stable at 13.75% in the next meeting, in two weeks, keeping them at this level thereafter. But 20% predict a further increase, to 14% per year.

The market is calculating that there will be less room for interest rate cuts in 2023. Before, the median of the analysts’ projections indicated an interest rate of 11% per year at the end of 2023; now, they see the rate at 11.25% per year.

Besides the worsening of fiscal risk after the budget bill was sent to Congress, inflation expectations for 2024 may have been influenced by the second-quarter GDP data, which show that the economy is growing above expectations – a development that may hinder the Central Bank’s efforts to slow down inflation.

The map of the distribution of inflation expectations shows that only a little more than a quarter of economic analysts believe that inflation will stay within the target in 2024, set at 3%.

More than 30% of analysts think it will stay well above the target, in the range between 3.68% and 4.28%. The mapping also shows an upward bias in expectations for 2025, with about 40% of analysts projecting inflation above the target of 3%.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Falling inflation expectations are off Central Bank’s horizon

Drop has not yet been able to positively contaminate projections for longer-term inflation

08/23/2022

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

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

Inflation expectations for this year and next have dropped substantially last week, but there was no benefit, for now, in the time horizon that really counts for the conduct of monetary policy.

The market’s inflation forecast for 2023 declined to 5.33% from 5.38% last week. At this percentage, it exceeds both the center of the inflation target range pursued by the Central Bank (3.25%) and the top of the range (5%). But the drop represents an important improvement.

It is very likely that such a decline was caused by a slowdown in current inflation. Central Bank President Roberto Campos Neto predicted, in a statement last week, that the more favorable inflation rates in the short term could have positive effects on longer-term inflation expectations.

In fact, the inflation projection for this year has been receding strongly after the government cut taxes to lower fuel and other prices, and the price of oil fell on the international market.

As a result, the market’s inflation projection for this year went to 6.82% from 7.02%. The economic analysts that renewed their projections in the past five days already forecast even lower inflation, at 6.69%.

But this lower inflation has not yet been able to positively contaminate the inflation projections for the longer term. The inflation rate expected by the market for the 12-month period ending in March 2024 is at 4.47%. It is more or less stable compared to the 4.48% a week earlier when considering the monthly inflation projections of the period.

The market projection is well above the informal target for the period, of 3.18%, calculated from the interpolation of the 2023 (3.25%) and 2024 (3%) goals. The Central Bank, however, estimates inflation at 3.5%. Last week, Mr. Campos Neto said that this spread between the official projection and that of the market could be explained by the fact that the monetary authority estimates a stronger impact of the interest rate hikes made since March 2021 to lower the price index.

The Central Bank decided to focus more on the March 2024 target because, according to its reasoning, the deadline is distant enough to not be contaminated by the temporary tax-cut measures put in place by the government. Some of these are to be reviewed in the first quarter of 2023.

The government, however, is beginning to discuss extending tax cuts in early 2023 as well. Since these measures are being taken in a fiscally unsustainable manner, without the support of permanent revenue gains, the benefits may have to be revised again – which should increase uncertainty about inflation projections for 2024.

Some analysts, however, believe that the slowdown in short-term inflation could have permanent positive effects on longer-term expectations. According to this reasoning, expectations are very much influenced by what happens to current inflation, although the theory says that it should only be determined by the underlying inflation trend.

Inflation expectations for 2024 were steady at 4.41% last week, after rising from 3.3% the week before. Leading indicators are dubious about what might happen in the coming weeks.

The average of expectations (sum of projections, divided by the number of projections) is at 4.47%, above the median of projections (projection with the most central value), which is the official indicator of expectations. This suggests that projections may rise.

The median of the projections of the 78 analysts that renewed their estimates in the last five days fell to 4.3% from 4.42% last week. It is thus lower than the 4.41% median of the 116 analysts that updated their projections in the past 30 days, which is the official measure of expectations.

By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Central Bank’s survey calls into question inflation scenario

Monetary authority is excessively optimistic compared with projections of private-sector analysts

07/08/2022

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

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

A survey carried out by the Central Bank with economic analysts before the last policy meeting, in June, and released Thursday morning puts at stake the inflation scenario outlined by the monetary authority, which is excessively optimistic compared with the projections of private-sector analysts.

In the June meeting, the Central Bank’s Monetary Policy Committee (Copom) projected a 4% inflation rate for 2023, the year that until then was the main target for monetary tightening. But the survey carried out days before the meeting shows that few market analysts think this is possible.

The median inflation projection for 2023 collected in the survey with 99 segments of the financial market, was 4.7%, as already unveiled by the Copom in its minutes. But now the survey reveals how the view of analysts is distributed around this median.

The first quartile of projections, that is, the group of most optimistic analysts, pointed to an inflation rate of 4.33%. In other words, less than a quarter of the analysts thought it was possible for inflation to stay below 4.33%. The highest quartile pointed to inflation of 5.1%.

In the June meeting, the Copom concluded that the balance of risks surrounding to inflation was symmetrical. That is, the upside risks to inflation, in relation to what was projected, were balanced with the downside risks.

This is a very different view from that expressed by financial market analysts: 76% identified predominant upside risks in their inflation projections for 2023, while 19% considered the risks balanced.

The divergence between the Central Bank’s and the financial market’s inflation projections, as well as the distinct views on the balance of risks, have repercussions on the credibility of the monetary policy strategy outlined by the Copom.

In practice, Copom is stating, based on its projections, that it will be possible to reach the inflation targets in 2023 without many additional hikes in the key interest rate, which in June was raised to 13.25% per year from 12.75% per year. The policymakers indicated a new hike for August, to 13.5% or 13.75%, and the maintenance of higher interest rates for longer.

The market’s consensus scenario for the economic slack is also more conservative than the Copom’s. The committee projects economic growth this year of 1.7%, higher than the 1.5% then expected in the median of market projections. Even so, the Copom thinks that economic slack will be higher at the end of this year, at 1.8%, compared with 1.5% expected by the market. The greater the slack, technically measured by the output gap, the greater the disinflationary force.

Since the slack estimated by the Central Bank and the market are very similar for the first quarter of this year, at 1.1% and 1%, respectively, the Copom is possibly estimating a higher potential GDP than the market – that is, the Central Bank would have a slightly more optimistic view than the market about how much the economy could grow without pressuring inflation.

Historically, the inflation scenario outlined by the Central Bank was not very different from that estimated by the financial market, but in the last year this divergence has widened. The monetary authority has been systematically projecting lower inflation than the market.

Normally, the inflation projected by the Central Bank diverges less than 0.3 percentage points from that of the market, for the relevant horizon of monetary policy. Last March, this divergence rose to 0.6 points and, as of May, to 0.7 points.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Central Bank have not intervened in exchange rate since May

This offers glimpse of monetary authority’s view over factors that pressure rate

07/07/2022

Policymakers have yet to unveil their view about recent currency swings — Foto: Pexels

Policymakers have yet to unveil their view about recent currency swings — Foto: Pexels

Despite the substantial increase in the foreign exchange rate, the Brazilian Central Bank has refrained from intervening in the market by selling hard currency from its reserves since early May. Brokers told Valor that this is the right strategy, since the recent pressure is linked to global factors and a move to reprice fiscal risks.

The exchange rate has been up 14.2% since May 31, when it closed at R$4.72 to the dollar. The rate closed at R$5.39 to the dollar on Tuesday.

The rate moved without the Central Bank making any extraordinary offering of dollars in the spot or futures markets, besides the typical rollover of maturing currency swap contracts.

Some brokers believe that the Central Bank’s failure to intervene in the market offers a glimpse of the monetary authority’s view over the factors that pressure the foreign exchange rate: this view must adjust to a fiscal risk seen as higher after the federal government and Congress maneuvered to pass measures allowing vote-getting spending and the U.S. Federal Reserve raised interest rates, which impacts the global economy.

According to the official narrative, the Central Bank intervenes in the exchange rate when the market is dysfunctional – for example when there is low liquidity and problems in price formation. But, if history is any guide, the monetary authority intervenes as well to cushion currency volatility – in other words, to minimize currency swings not justified by the fundamentals.

The policymakers have yet to unveil their view about recent currency swings. However, many market players will see it as a natural move if the Central Bank acknowledges that the exchange rate will be impacted by the worsening of the fiscal risk. In addition, the real is now losing ground against the dollar as other currencies did, like the euro, which reached its weakest level in two decades.

If this really is the Central Bank’s view, there will mean a substantial change in relation to what the monetary authority had been saying since three months ago, when more upbeat perspectives for the real prevailed. In early April, when the exchange rate was testing the floor of R$4.6 to the dollar, Central Bank President Roberto Campos Neto even said that the market’s inflation expectations were not fully reflecting the stronger real.

One year ago, the Central Bank’s Monetary Policy Committee (Copom) hopes that a potentially stronger real would help it disinflate the economy. The monetary authority unveiled, in a section of the inflation report for June 2021, that it saw chances of commodity prices falling in reais. Since then, the information is seen as a positive factor in the balance of risks for inflation.

In early April, many economic analysts said that the exchange rate was unlikely to decline in the second half of the year because of the monetary tightening in the United States and the risks linked to the presidential election, to be held in October in Brazil. Later in the same month, the risks of a stronger deceleration in China weighed on the real as well.

When the real was gaining ground, some analysts questioned at some point if the Central Bank should intervene and buy dollars to slow down an appreciation that many people considered temporary. Mr. Campos Neto signed then the opposite, that the Central Bank was ready to act if monetary tightening in the United States caused dysfunctionality in the markets.

The exchange rate is now nearly 10% higher than the level of R$4.9 to the dollar used by the Copom in the inflation projection models in its last policy meeting, in June. But, as far as monetary policy is concerned, the data set, including the likely impact of recent declining prices of commodities in inflation, is what matters.

But some economic analysts have argued that the decline in commodity prices reaches inflation through other channels. One is heightened fiscal risk since a good part of the federal government’s populist fiscal measures is propped up by higher revenues brought by high prices of commodities.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Central Bank’s inflation scenario affected by economic slack

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

07/01/2022

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

https://valorinternational.globo.com/
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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

06/21/2022

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

https://valorinternational.globo.com/
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Analysis: Should Central Bank reassess fiscal risks?

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

06/08/2022

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

https://valorinternational.globo.com/
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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

https://valorinternational.globo.com

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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

https://valorinternational.globo.com

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