Itaú BBA - BCB signals interest rate at 7.0% by year-end

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BCB signals interest rate at 7.0% by year-end

November 1, 2017

We keep, for now, our call that the end will only come in February, with a final 50bps rate cut, taking the Selic to 6.5%pa.

The Brazilian economy in October 2017

The Brazilian Central Bank’s Monetary Policy Committee (Copom) unanimously decided to cut the benchmark Selic interest rate by 75 bps to 7.5%. The Ibope survey showed former President Lula as the front-runner in the presidential race, with 35% of voting intentions. In a 251-233 vote, the main floor of the Lower House approved the report rejecting accusations against President Michel Temer. The Lower House approved the creation of a public fund to finance election campaigns. The official economic cycles committee (CODACE) established the end of the recession in 4Q16. The federal government took in 6.15 billion reais after auctioning six oil exploration blocks in the second and third rounds of pre-salt auctions. The unemployment rate receded to 12.4% in September.

Loud and clear, the Central Bank signals the interest rate at 7.0% by year-end

The Copom delivered the widely expected outcome, a 75bps rate cut to 7.5% p.a., in a unanimous vote. The meeting’s statement and minutes suggest that the plan remains to slow down the pace of easing moderately, which, based on a communication pattern established by this Copom, we read as a signal that the December move will probably be a 50bps-reduction that would take the Selic to 7.0% p.a. After that, the Copom would begin 2018 with another cut, of 50 bps, taking the Selic to 6.5% at the end of the cycle – although we concede that the statement and minutes of the last meeting hint at the cycle possibly ending this year (click here).

Ibope survey shows Lula leading the presidential race

In a survey published by O Globo newspaper, Lula got 35% of voting intentions, followed by Jair Bolsonaro (13%), Marina Silva (8%), Geraldo Alckmin (5%), and João Dória Jr. (4%). In the spontaneous survey (in which candidates names are not given), Lula received 26% of voting intentions, followed by Bolsonaro (9%), Marina (2%), Alckmin and Dória (1% each). In a scenario without Lula in the race, Bolsonaro and Marina Silva each had 15%, followed by Luciano Huck (8%), Alckmin (7%) and Dória (5%). This was Ibope’s first survey on the 2018 presidential election.

Lower House rejects second round of charges against Temer

In a 251-233 vote, the main floor of the Lower House rejected charges against President Michel Temer and his Chief of Staff Eliseu Padilha and Secretary-General Moreira Franco, accused of criminal organization and obstruction of Justice. After the vote, the government signaled that it will focus on the reform agenda, particularly the pension reform.

Congress votes on political reform draft

The Congress finished the voting on a draft of the political reform. The Lower House approved the creation of a public fund to finance election campaigns, in a move that will funnel about 2 billion reais to candidates in 2018. That amount will add to the 1 billion reais already in the Parties Fund. The change came after the Supreme Court forbade corporate donations to election campaigns. Furthermore, the Senate approved the constitutional amendment ending alliances in elections for state and municipal representatives and created a performance clause, setting a minimum share of votes for each party.

CODACE marks the end of the recession in 4Q16

The official committee that sets the dates for economic cycles (CODACE) met and established that the recession ended in 4Q16, lasting 11 quarters and accumulating a drop of 8.6%. The committee has marked recession and expansion cycles since 1Q80. The most recent cycle was the longest in the series (matching the 3Q89-1Q92 timeframe) and accumulated the sharpest decline (matching the 8.5% contraction seen in 1Q81-1Q83).

Sharper-than-expected slide in activity indicators 

August was marked by disappointment with industrial production, retail sales, real revenues from services and the labor market. Retail sales dropped 0.5% mom/sa in August, below expectations. Stagnation in the past two months may reflect a reversal of the temporary boost provided by withdrawals from inactive accounts held under employment protection program FGTS. We expect the trend of gradual recovery to resume in the coming months, influenced by falling interest rates and lower household debt levels, as well as by the gradual improvement in the labor market. Two more seasonally-adjusted indicators disappointed expectations, as industrial production declined 0.8% in August and just 34,000 formal jobs were created in September.

Confidence indicators are still on the rise 

Confidence indicators, published by FGV, show widespread improvement in October. A preliminary reading among industrial entrepreneurs advanced 2.0% during the month, with positive results in the components that appraise the current situation (4.9%), notwithstanding deterioration in expectations for the future (-0.4%). After falling in June amidst rising political uncertainty, the indicator sustains an upward trend, in line with the gradual recovery in economic activity. In the same spirit, confidence rose 3.7% among retail entrepreneurs and went up 0.6% in the construction industry, marking a fifth consecutive increase and signaling that the modest recovery in the sector in 3Q17 should extend into 4Q17. Consumer confidence increased 1.7% in October, matching the previous month’s pace. Components addressing expectations for the future (0.8%) and the current situation (3.2%) both advanced.

Labor market is driven by growth in informal jobs

According to the national household survey (PNAD Contínua - IBGE), Brazil’s nation-wide unemployment rate declined to 12.4% in 3Q17 from 12.6% in the quarter ended in August. Using our seasonal adjustment, unemployment was stable at 12.6%. The trend is still influenced mainly by informal jobs. The increase in employment in September was particularly noticeable in the “domestic worker” category, up by 236,000 people vs. the previous month. The real wage bill expanded 3.9% yoy and 1.2% vs. 2Q17.

Inflation remains low

The mid-month consumer price index IPCA-15 climbed 0.34% in October, in line with expectations. Year-over-year inflation accelerated to 2.71% from 2.56% in September, and remains below the lower bound of the range around the 3% target. Transportation (0.11 p.p.) and housing (0.10 p.p.) provided the largest upward contributions during the month, driven by auto fuels and bottled cooking gas. On the opposite side, food and personal expenses reported negative readings. 

Narrower-than-expected primary budget deficit in September 

The consolidated public sector posted a primary deficit of 21.3 billion reais in September, below expectations. The consolidated primary deficit accumulated over 12 months remained at 2.4% of GDP. The central government’s result, as published by the National Treasury, was a deficit of 22.7 billion reais in September, with the surprise reflecting lower transfers to states and municipalities and lower discretionary spending. Regional governments and state-owned companies also posted stronger-than-expected readings, with surpluses of 0.8 billion and 0.2 billion reais (while we anticipated deficits of 0.5 billion and 0.4 billion, respectively). In our view, the government will be able to meet its target for the year, a primary deficit of 162 billion reais (-2.4% of GDP), for the consolidated public sector. In terms of revenues, the 105.6 billion reais in intakes beat expectations, with strong real annual growth, again with widespread expansion across components. The government’s coffers were boosted by the auction of six oil exploration blocks in the second and third rounds of the pre-salt auctions, which produced 6.15 billion reais. Notwithstanding positive surprises in the latest monthly report, fiscal readings remain in a structural trend of deterioration, reinforcing the extreme importance of reforms (particularly the pension reform) to correct the nation’s fiscal imbalance.

Current account surplus surprises in September 

The current account surplus came in at US$ 434 million in September, well above expectations. Over 12 months, the current account deficit fell to US$ 12.6 billion or 0.6% of GDP. The biggest positive contribution came once again from the trade balance, which posted a US$ 4.9 billion surplus, up from US$ 3.6 billion in September 2016. The trade surplus has been losing momentum due to the decline in commodity prices and some rebound in economic activity. Yet, a strong trade balance will continue to be the main factor supporting a low current account deficit.

Financial assets 

In October, the Ibovespa fell 3.3% in dollars and maintained the previous month’s level in local currency. Country risk measured by the five-year CDS fell to 172 bps. The exchange rate depreciated to BRL 3.27 per dollar.

What’s next

After the main floor of the Lower House rejected charges against President Temer, the focus is back to the reform agenda, particularly the pension reform.

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