On the eve of the Copom meeting, de-anchored inflation worries agents

01/30/2023

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Agents expect key interest rate Selic to remain at 13.75% on Wednesday — Foto: Marcello Casal Jr/Agência Brasil

The recent criticism the current administration has made of inflation targets and the persistence of fiscal uncertainties have translated into a movement of de-anchoring of inflation expectations. That is happening in a scenario that increasingly detaches market agents from the prospect that the Central Bank’s Monetary Policy Committee (Copom) begins the cycle of interest rate cuts.

Despite that, the improvement in current inflation and signs of a turnaround in the trend of rising prices around the world are likely to oppose local noises and guarantee that Copom’s balance of risks remains symmetrical in Wednesday’s decision — even though the collegiate may use a harsher tone when addressing the detachment of expectations.

According to a survey conducted by Valor with 106 institutions, there is unanimity among the agents about the key interest rate Selic remaining stationary at 13.75% on Wednesday. For the end of the year, however, the projections range from cuts in the rate to 10.5% to a rise to 14.5% — the chance of an interest rate increase, however, is projected by only one institution.

However, the projections for the Selic have contemplated fewer and fewer cuts. While the median of the last survey carried out by Valor, in December, indicated the Selic at 12% at the end of this year, the number has jumped to 12.50% now.

At the same time that it expects a less intense monetary loosening cycle, the market has raised its inflation projections. The median of 102 estimates for inflation at the end of 2023 rose to 5.7% from 5.2% in December. For 2024, the midpoint of the projections jumped to 4% from 3.7%.

In the context of worsening inflationary expectations, financial agents expect the collegiate to harden the tone of communication, but not to change the balance of risks significantly yet.

“Given this very evident movement of unanchoring that is expected to continue, I wouldn’t be surprised if the committee stressed this issue,” says the chief economist for Brazil at BTG Pactual, Claudio Ferraz. He also reminds us that, in December, Copom has already demonstrated concern with expectations, when it pointed to the average of the benchmark inflation index IPCA projections for 2024.

A similar view is adopted by the chief economist at Truxt Investimentos, Arthur Carvalho. “By analyzing the communication from the Central Bank, it is possible to see that, little by little, it has been raising the tone a bit concerning fiscal policy and the potential effects on monetary policy. This was very clear in the letter about the 2022 target, which was not met, when the Central Bank shows that the more expansionary fiscal policy was part of the problem. And now, despite well-behaved current inflation and signs of a slowdown in the economy, the only explanation for the unanchoring of expectations is a fiscal environment that accommodates higher spending growth and makes the 3% inflation target not very credible.”

Mr. Carvalho says he has a feeling that Copom will, again, raise the tone regarding fiscal policy. “If we hadn’t seen this lack of support, Copom would probably be signaling the beginning of a process of loosening interest rates. I think the Central Bank will harden its tone, but despite that, the balance of risks will remain symmetrical,” he says. Truxt expects three 50 basis-points cuts in interest rates this year but emphasizes the uncertainty present in the scenario.

Claudio Ferraz, from BTG, observes that the recent movements induce the impression that the beginning of the Selic cuts “are more distant, smaller and, depending on decisions about the fiscal framework, perhaps the “terminal number” of the Selic will be higher. In an environment of de-anchoring of expectations, the space is exhausted.”

Without seeing significant changes that justify a change in the BC’s flight plan, XP’s chief economist Caio Megale believes that Copom should indicate that there are positive elements in the scenario but emphasize that “the concerns described in the past meeting have intensified.” “If Copom comes with a very different tone, it would be a surprise,” he says.

From now on, for Mr. Megale, the behavior of inflation projections for 2024 should be monitored. “When expectations rise, the Central Bank’s model has to incorporate a longer interest rate stop in order to achieve convergence. We believe that, up to the 4.5% level [for the IPCA of 2024], the Central Bank would manage to bring inflation to the target only with interest rates unchanged for a longer time. But if expectations exceed the top of the band, the scenario would be more difficult.”

And it is in the face of higher inflationary expectations and fiscal uncertainty that the chief economist at Garde Asset, Daniel Weeks, believes that Copom may change the balance of risks. “After the approval of the PEC, the fiscal risk increased and, more recently, we have seen communication by the Treasury and the president about inflation targeting, which affects the credibility of the CB and unanchoring expectations.”

For him, Copom should reinforce the message of maintaining a contractionary monetary policy for a prolonged time. “I think the Central Bank should have already changed the balance of risks in December, when there was already a worsening because of fiscal risk. I don’t know if it will change now, but it should, because, from the last Copom to here, we saw the approval, in fact, of the PEC [proposal to amend the Constitution] and, now, a worsening of expectations and pressure on the Central Bank itself.”

When simulating the Central Bank models, EQI Asset’s chief economist, Stephan Kautz, expects the projection for the IPCA of 2023 to rise to 5.2% from 5% and that the estimate for the IPCA of 2024 will go to 2.9% from 3%. “This is because, concerning the last Copom, there was an improvement in the exchange rate and the trajectory of the Selic in 2023 went to 12.5% from 11.75%. The lower exchange rate and higher interest rates offset the shock in expectations and the projections may move little,” he says.

Mr. Kautz believes, however, that the members of Copom may seek to convey a slightly more cautious message about the de-anchoring of expectations and reminds us that part of the Central Bank’s credibility depends on the anchoring of inflation over the medium term.

*By Gabriel Roca, Victor Rezende — São Paulo

Source: Valor International

https://valorinternational.globo.com/