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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

https://valorinternational.globo.com

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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

https://valorinternational.globo.com

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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

https://valorinternational.globo.com

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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

https://valorinternational.globo.com

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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

https://valorinternational.globo.com

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Central Bank increases fourfold renminbi share in FX reserves

Brazilian Central Bank increased the renminbi share in its foreign exchange reserves — Foto: Tomohiro Ohsumi/Bloomberg
Brazilian Central Bank increased the renminbi share in its foreign exchange reserves — Foto: Tomohiro Ohsumi/Bloomberg

Faced with rising inflationary pressure and monetary tightening in major economies, the Brazilian Central Bank increased the renminbi share in its foreign exchange reserves to 4.99% in 2021, the highest since the Chinese currency became part of the basket in 2019.

The share is four times higher than the previous year’s allocation, of 1.21%. The increase represented, in nominal terms, $13.766 billion more in assets measured in renminbi. At the same time, the representation of the U.S. dollar fell 5.69 percentage points over 2020 and stood at 80.34% in the period, the lowest since 2014. The drop is equivalent to $15.276 billion.

The share of the euro dropped as well, to 5.04% in 2021 from 7.85% in 2020, a reduction of $9.691 billion. The Central Bank did not elaborate on why it decided to reduce investments in the greenback. Yet, with high inflation and the prospect of interest rates being raised by the U.S. Federal Reserve, the prices of the main asset in the reserves (U.S. Treasury bonds) are likely to fall. In addition, inflationary pressure has also risen in the euro zone, generating the same effect on European securities.

There is even greater incentive to invest in renminbi after the United States blocked Russian investments in dollars. As a result, some economists argue that the Chinese currency is likely to gain prominence in the countries’ forex reserves.

In the report, however, the Brazilian Central Bank refers only to the profitability of currencies. According to the monetary authority, assets in renminbi have higher yields than those in dollars, although they have the same risk as the total curve of U.S. securities.

The Central Bank has also increased the share invested in sterling, to 3.47% in 2021 from 2.02% in 2020, as the United Kingdom is further ahead in the process of monetary tightening. The position in gold, another typical hedge against inflation, increased to 2.25% from 1.19%.

The monetary authority has also resumed investments in Canadian and Australian dollars in 2021. These investments were reduced to zero a few years ago because these currencies have a high correlation with the real, since they are from commodity-producing countries and have also been used by investors as a protection against inflationary risks.

Source: Valor International

https://valorinternational.globo.com

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Analysis: Survey tests Central Bank’s plan to stop raising rates

The Focus bulletin of financial market expectations represents a first warning sign to Central Bank’s strategy of stopping interest rates hikes in May at 12.75% per year, compared with 11.75% per year now.

Interest rate projections for the end of the monetary tightening cycle remained at 13% per year. But inflation expectations have gone up again.

Not only the IPCA – Brazil’s official inflation index – forecast by analysts for 2023, which is the main target of the interest rate policy, worsened. The forecast for 2024 also went up, which represents a further deterioration in long-term expectations.

The median inflation projection for 2023 rose to 3.8% from 3.75%, compared to an inflation target of 3.25%. There are leading indicators that it may move higher. The average of the projections is at 3.84%, and the median of the analysts that have revised their forecasts in the last five days is already at 3.9%.

The combination that many analysts believe could lead the Central Bank to review its interest rate plans happened last week: the rise in current inflation has caused a deterioration in long-term inflation expectations.

Two new facts may have contributed to the deterioration in expectations. First, the clear signal from the Central Bank that it is willing to stop the tightening cycle unless inflation surprises upwards.

Second, on Friday the preliminary reading IPCA-15 for March was released, at 0.95%, higher than forecast by the market. Analysts are revising their bets for the month’s price index to above 1.2%.

In theory, this short-term surprise is unlikely to contaminate inflation in 2023 and even less so in 2024.

Central Bank President Roberto Campos Neto was asked last week why the market was betting on current inflation for March higher than the 1.02% variation estimated by the monetary authority.

He answered that this short-term pressure was due to a faster pass-through of fuel adjustments unveiled by Petrobras. For him, the stronger increase in the very short term is likely to be offset by lower inflation later on. Thus, when analyzing a group of months, the effects would compensate each other, to a good extent.

The Focus data, however, show that the market has not made this compensation, at least for the time being. The inflation projected by economic analysts for this year rose to 6.86% from 6.59% in one week.

According to market projections, the 12-month inflation will continue to rise until May, exceeding 11%. It will only fall back below double-digit levels in July.

This heavier current inflation is contaminating more distant years. The market forecast for the IPCA in 2024 rose to 3.20% from 3.15%, compared with a target of 3%. The average of the projections for inflation in 2024 already stands at 3.27%.

Source: Valor International

https://valorinternational.globo.com

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Central Bank raises interest rate, signals new hike

For the next meeting, the Copom foresees another adjustment of the same magnitude — Foto: Jorge William/Agência O Globo
For the next meeting, the Copom foresees another adjustment of the same magnitude — Foto: Jorge William/Agência O Globo

The Central Bank’s Monetary Policy Committee (Copom) raised on Wednesday the Selic, Brazil’s benchmark interest rate, by 100 basis points, to 11.75% per year. This is the ninth consecutive increase. For the next meeting, the Copom foresees another adjustment of the same magnitude.

“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, on the balance of risks, and on inflation expectations and projections for the relevant horizon for monetary policy,” says the committee’s statement.

This Wednesday’s decision was in line with the median of market expectations and within what was signaled by the monetary authority at the previous meeting – at the February meeting, the Central Bank indicated it would reduce the pace of monetary tightening, but did not specify the magnitude of the next adjustments. At the time, the Selic was raised by 150 bp, to 10.75% per year

In a survey carried out by Valor with 93 financial and consultancy firms, 82 expected the Selic to be raised by 100 bp, to 11.75%. Nine projected a 125 bp increase, while two believed the committee would keep the pace of interest rate hikes at 150 bp.

The Copom meets again on May 3 and 4.

For the Copom, in the external scenario, the environment has deteriorated substantially. “The conflict between Russia and Ukraine has led to a strong tightening in financial conditions and higher uncertainty surrounding the global economic outlook”, it stated. “In particular, the supply shock resulting from the conflict has the potential of increasing inflationary pressures, which had already been rising both in emerging and advanced economies.”

The committee says that it considers it appropriate for interest rates to advance significantly towards an even more contractionary terrain and “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 an even more restrictive territory.”

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

In the statement, the Central Bank stressed that various measures of underlying inflation are above the range compatible with meeting the inflation target.

Regarding Brazilian economic activity, the Copom highlighted that the release of the GDP figures for the fourth quarter of 2021 indicated a higher-than-expected pace of activity.

The committee states that “the current projections indicate that the interest rate cycle in its scenarios is sufficient for inflation convergence to levels around the target over the relevant horizon.”

The Copom published two inflation projection scenarios, both considering a rise in basic interest rates to 12.75% per year, with a fall to 8.75% per year next year.

“The committee’s actions aim at curbing the second-round effects of the current supply shock in several commodities, which appear in inflation in a lagged manner”, it stated. “The Copom judges that the moment requires serenity to assess the size and duration of the current shocks.”

“If those shocks prove to be more persistent or larger than anticipated, the Committee will be ready to adjust the size of the monetary tightening cycle. The committee emphasizes that it will persist in its strategy until the disinflation process and the expectation anchoring around its targets consolidate,” the statement continues.

“The Committee assesses that the uncertainties regarding the fiscal framework maintain elevated the risk of deanchoring inflation expectations, but considers that this risk is being partially incorporated in the inflation expectations and asset prices used in its models. The Committee maintains the assessment of an upward asymmetry in the balance of risks.

The committee still sees both upside and downside risks to inflation.

“On the one hand, a possible reversion, even if partial, of the increase in the price of international commodities measured in local currency would produce a lower-than-projected inflation in its scenarios,” says the document.

“On the other hand, fiscal policies that imply additional impulses to aggregate demand or deteriorate the future fiscal path may have a negative impact on prices of important financial assets as well as pressure the country’s risk premium.”

Source: Valor International

https://valorinternational.globo.com

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Central Bank raises interest to 10.75%, indicates slower pace in new hikes

Interest rates expected to rise more slowly now — Foto: Pixabay

With a resistant inflation that tends to burst again this year’s target, the Central Bank’s Monetary Policy Committee (Copom) this Wednesday raised the basic interest rate by 150 basis points, to 10.75% per year. The Selic has not been in double digits since July 2017, when it went to 9.25% from 10.25% per year.

“The Committee judges that this decision reflects its reference scenario for prospective inflation, a 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 2022 and, to a larger degree, 2023. Without compromising its fundamental objective of ensuring price stability, this decision also implies smoothing of economic fluctuations and fosters full employment”, said the Central Bank in the statement released after the meeting.

According to the committee, in spite of the more favorable public accounts data, “uncertainties regarding the fiscal framework maintain elevated the risk of deanchoring inflation expectations and, therefore, the upward asymmetry in the balance of risks”

Copom signaled that from now on it will reduce the pace of monetary tightening, but reinforced that the Selic rate should advance “significantly into the restrictive territory” on the relevant horizon.

“This indication [of a reduction in the pace] reflects the stage of the tightening cycle as its cumulative effects will manifest themselves over the relevant horizon,” justified the committee in the decision statement. In practice, this means that the Selic is already at high levels and that it will still take some time for the effects on inflation to be noticed.

The Central Bank highlighted that the increase is compatible with the convergence of inflation to the targets over the relevant horizon, which now includes 2022 and, to a greater extent, 2023. The next meeting, in March, is the last in which the BC considers this year’s target for monetary policy decisions.

“The Committee judges that this decision reflects its reference scenario for prospective inflation, a higher-than-usual variance in the balance of risks”, the committee highlighted.

Although it indicated a deceleration in the rate of interest rate hikes, the committee highlighted the increase in its inflation forecasts and the risk of de-anchoring expectations for longer terms. In addition, he emphasized that “it will persist in its strategy until the disinflation process and the expectation anchoring around its targets consolidate”.

The decision was in line with the market consensus, which was for an increase of 150 basis points, as signaled by the monetary authority at the previous meeting, in December. At the time, the Selic was raised by 150bp, to 9.25% per year, and the committee said in its statement that it anticipated “another adjustment of the same magnitude” for the meeting on Wednesday.

This was the eighth consecutive hike in the basic interest rate.

In a survey carried out by Valor on Monday with 112 financial institutions and consultancies, the expectation was unanimous that the Selic rate would be raised this week by 150 bp, to 10.75% from 9.25% per year.

The interest rate shock began in March last year — when the Selic was at 2% — and has been applied to cool the economy in response to rising prices and higher expectations of rising inflation expectations for this year. The reflexes of the Selic can be seen in the financing of home ownership, government debt, productive investments and consumption.

In the anteroom of the Copom decision, the stock market and the exchange rate had a correction movement after a sequence of positive results.

Pressured by the banking sector, in which Santander’s less-good-than-expected earnings balance published by the bank, benchmark stock index Ibovespa returned to operate at the level of 112,000 points. The commercial dollar, on the other hand, surpassed R$5.30, but ended up losing strength in the last hour of trading and closed practically stable.

After adjustments, the reference index of the local stock market closed down 1.18%, at 111,894.36 points. Negative highlight of the trading session, Santander units fell 2.99%, pulling with them other shares in the segment: Itaú Unibanco shares fell 1.57%, while Bradesco common and preferential shares dropped 1.68% and 1.81%, respectively.

In the case of the exchange rate, the prospect of a higher Selic rate, which increases the differential with the outside world, weighs positively – one of the components of the attractiveness of any currency. After hitting R$5.3145 at the maximum of the day, the dollar closed at R$5.2754, a rise of only 0.09%. As a result, it remains at the lowest levels since September.

(Marcelo Osakabe, Gabriel Roca and Victor Rezende contributed to this story)

Source: Valor International

https://valorinternational.globo.com

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World’s largest rate hike casts doubt on Central Bank’s power to fight inflation

Inflation, hyperinflation and deflation? | Tendercapital

Brazil was the country that raised interest rates the most in 2021 and yet boasts one of the highest consumer inflation expectations for this year when compared to its peers. For some analysts, the figures show that inflation in Brazil has reacted little to increases in the Selic policy interest rate. This theory diverges from what members of the Central Bank’s Monetary Policy Committee (Copom) and other economists argue. They say monetary policy has gained “power” in recent years, as inflation is reacting more than before to changes in the basic interest rate. The discussion may gain substance among economists in 2022, in an environment of still pressured inflation and a presidential election.

A survey by Emilio Chernavsky, doctor of Economics from the University of São Paulo, shows, for example, that the variation in interest rates in Brazil was much larger than in other countries. According to data from the Bank for International Settlements, the 7.25 percentage points hike in the Selic last year puts Brazil firmly in the lead of the ranking of countries with the biggest increases in the basic interest rate. In second place comes Russia, with 3.25 points. In the case of consumer inflation expectations for this year, Brazil has the fifth highest estimate, of 4%, behind Turkey (14.5%), India (4.9%), South Africa (4.5%) and Russia (4.3%), according to the International Monetary Fund.

“Monetary policy is very little effective in Brazil,” Mr. Chernavsky said. “We were by far the country that raised the basic interest rate the most, and this did not lead us to comfortable inflation, despite the fact that our economy is already stagnant,” he added, pointing out that the cycle of hikes has not yet ended. The median projection of Focus, Central Bank’s weekly survey with economists, for the basic interest rate, currently at 9.25% a year, is 11.75% by the end of 2022.

The economist cites some reasons why he considers that monetary policy is not very effective in Brazil. One is the fact that commodities and regulated prices have a large weight in the Extended Consumer Price Index (IPCA), Brazil’s official inflation. In practice, this means that changes in the basic interest rate affect only 70% of the IPCA, according to him. Another reason is the high volatility of the real, which in many cases generates a “precautionary cost pass-through.”

He also highlights the role of “systematically large” spreads in Brazil, or the difference between the rates charged for loans and for raising funds. Mr. Chernavsky cited credit cards as an example, “one of the main ways of financing consumer spending” in the country.

“In the case of a 7-percentage point increase in the Selic, even if this is passed on in full, the final rate will rise, say, to 307% per year from 300%,” he said. “The impact on the loan installment will be negligible.”

On the other hand, increases in the Selic rate of the same magnitude increase costs for companies by putting greater pressure on the cost of working capital lines of credit, whose annual rates “are at 20%, 30%.”

“So the thing is: the credit channel works very badly,” he said. “Selic hikes hardly impact demand, but increase costs for companies. So the net effect on inflation ends up being small.”

Given these distortions, Mr. Chernavsky is in favor of using other instruments besides the basic interest rate to keep inflation in check. Among them are reserve requirements (collected by the Central Bank through rates levied on funds raised by financial firms), a Tax on Financial Transactions (IOF) and a “fiscal fund” to help give more stability to fuel prices.

The Central Bank has been defending the thesis of increased monetary policy power since 2019. In its quarterly inflation report for the first quarter of 2020, the monetary authority discussed the reasons why it considered that the power of the interest rate had increased. More recently, at the end of last year, the then director of economic policy, Fabio Kanczuk, reinforced this idea, citing the approval of the Long-Term Rate (TLP) in 2017 and the reduced role of the Brazilian Development Bank (BNDES) as reasons why inflation is reacting more to Selic hikes.

For Zeina Latif, an economic adviser at Gibraltar, it is not possible to say that the cycle of basic rate hikes last year and the inflation projections for this year show a loss of power of monetary policy.

“Any way to measure this now would be very limited because of natural lags in monetary policy,” she said. In the current cycle, the Central Bank first raised the basic interest rate in March last year, to 2.75% a year from 2%.

“We are now starting to feel some first signs of the hikes on economic activity,” she said. “Only then come the impacts on inflation. Definitely, there wasn’t time yet to feel the impacts on inflation.”

Ms. Latif says that monetary policy has gained power since the Rousseff administration, but believes that part of this gain was reversed in the last two years, when a “fiscal deterioration” began. The strongest sign, according to her, are the higher projections for the neutral interest rate, the one that neither accelerates nor decelerates inflation. In December, the Central Bank itself raised its estimate for the annual neutral interest rate in real terms, to 3.6% from 3%.

“If monetary policy is underpowered, the interest rate has to be higher. To stabilize inflation, you need to make a greater effort, so the neutral interest rate is higher,” she said. “Fiscal deterioration puts a burden on interest rates. There is no way. Monetary policy and fiscal policy are communicating vessels.”

Carlos Kawall, director at Asa Investments, says that “monetary policy clearly gained potency when there was the change of the parafiscal regime [linked to BNDES and subsidized interest rates] and the implementation of TLP.”

“Today it doesn’t seem that we have an ineffective monetary policy,” he said.

According to him, inflation in Brazil is “higher than the global average, but not as high as it was in the past.” The path of prices “higher and more resistant to decline” is a common factor to emerging countries, compounded in Brazil by the “inertial component,” which is how much past inflation affects current inflation. For Mr. Kawall, using the comparison between the cycle of interest rate hikes and inflation projections to say that monetary policy has little power is to “criticize the medicine instead of look at the disease itself.”

Source: Valor international

https://valorinternational.globo.com/

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