Economists discuss whether it’s time for monetary authority to revise forecasts of 50bp cuts in key interest rate

03/04/2024

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Gabriel Galípolo — Foto: Pedro França/Agência Senado

As monetary easing progresses in Brazil, a debate is gaining momentum in the market as to when the Central Bank’s Monetary Policy Committee (COPOM) will adjust the communication of its flight plan. The collegial body continues to point to rate cuts of 50 basis points in the next two meetings.

Some believe that less rigid communication from the COPOM could give the monetary authority more room to maneuver at a time of external uncertainty and fears about the trajectory of services inflation. Meanwhile, there are market participants who oppose an immediate change in the so-called forward guidance, arguing that it would add noise at a time of economic slowdown.

Last week, for the first time, this debate was raised more explicitly among COPOM members. The Central Bank’s director of monetary policy, Gabriel Galípolo, said the collegial body dared to start the cycle of interest rate cuts with forward guidance, a tool he described as “a very risky sport for emerging markets.” He made the comments during a presentation at an event organized by Money Report.

“We have engaged in this high-risk sport, and so far, it has paid off. We found a pace of cuts that allowed us to adjust the level of monetary tightening, with the nominal rate following the fall in inflation, while observing the reaction of the economy,” he said.

According to Mr. Galípolo, the instrument has so far helped to reduce the volatility surrounding the Central Bank’s actions in the local market. However, about forward guidance, he said there is an attitude of dependence on the monetary authority’s data. “But at some point, you’ll have to remove the plural [in the guidance] and that could generate a cost,” he said, without anticipating whether the discussion would be taken to the COPOM meeting this month.

The discussion about changing the Central Bank’s future guidance comes at a time when the COPOM has already cut the Selic policy rate by 250 basis points to 11.25% a year. Although there is room for further rate cuts in Brazil, analysts say the Central Bank’s approach of signaling the path of rates over a three-month horizon could prove risky in an environment of external volatility.

According to economists, maintaining a fixed orientation for the Selic rate removes degrees of freedom for the monetary authority, especially at a time when the cycle of rate cuts is already at an advanced stage.

If the COPOM confirms the guidance given in the last decision and market expectations, the Selic rate will fall to 10.75% at the March meeting. The forward guidance in the statement released after the most recent meeting, on January 31, indicates that “the members of the Committee unanimously foresee a reduction of the same magnitude at the next meetings”—with the use of the plural. Therefore, if this strategy is maintained, the rate is expected to fall to 10.25% per year in May and 9.75% at the June meeting.

The problem is that since the beginning of the year, bets on the start of monetary easing in the United States have been delayed. According to data from the CME Group, about a month ago, agents assigned an implicit probability of 99.5% that the Fed Funds would start to fall or would have already fallen by June. Today, there is a 33.7% chance that rates will remain unchanged until then.

At the same time, estimates for the Selic rate at the end of the cutting cycle have also been revised by market operators and last week reached the 9.75% level—a degree that could be reached in June if the COPOM maintains the pace of cuts and future orientation until then. In addition, the latest inflation figures continue to show pressure on components that are sensitive to monetary policy.

On the other hand, real interest rates in Brazil remain at very restrictive levels and, at this point, a change in communication would be a more conservative signaling on the part of the Central Bank.

According to a source from the market’s division of a local institution, the discussion about removing the use of the plural in the statement makes no sense now. “The Central Bank may have decided to implement this guidance to prevent the market from pricing in any chance of acceleration and also to stabilize the curve, sending a relatively hawkish message. By removing the plural at this stage of easing, and with such a high level of real rates, the authority would be adding unnecessary noise to the market and the economy, just when economic growth is starting to moderate,” he said.

For this source, the Central Bank already has a very conservative stance. “Both nominal rates and, especially, the current level of real rates are at very high levels, according to any metric. If you add inflation expectations and other important indicators, such as the exchange rate and commodity prices, to the equation, there is no relevant reason to expect a change in communication,” the source said.

*Por Gabriel Roca — São Paulo

Source: Valor International

https://valorinternational.globo.com/