Itaú BBA - Central Bank near the end of the easing cycle

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Central Bank near the end of the easing cycle

March 1, 2018

At its last meeting, the Central Bank of Brazil indicated that the monetary easing cycle is near its end.

The Brazilian economy in February 2018

The Central Bank reduced the benchmark Selic interest rate by 25 bps to 6.75% and signaled that, in the absence of positive data surprises, the easing cycle should be interrupted. Fitch followed S&P in downgrading Brazil’s credit rating. A military intervention was declared for public safety in Rio de Janeiro and the government delayed the pension reform vote. Economic activity is picking up, mostly driven by monetary policy stimuli. GDP expanded 1.0% in 2017. Inflation remains low, with a good composition. The central government posted a primary budget surplus of 31 billion reais in January and is expected to meet this year’s fiscal target without hardship.

Copom nears the end of the cycle

The Central Bank’s Monetary Policy Committee (Copom) reduced the benchmark Selic interest rate by 25 bps in its first meeting of the year and signaled that, in the absence of positive data surprises that point to an even more benign inflation scenario, the easing cycle should be interrupted in the March meeting. However, inflation remains low and with a good composition, possibly leading to another cut in the Selic rate in March, though this is not our baseline scenario. We forecast stability in the Selic rate at 6.75% until at least the end of 2018. High-frequency inflation data in Brazil (and the U.S.) must be monitored, along with the impact of such figures on expectations and the prospective scenario, in order to determine if the Copom may choose to add modest monetary stimulus.

Fitch follows S&P and downgrades Brazil’s credit rating

Fitch downgraded Brazil’s sovereign credit rating to BB- from BB, and changed its outlook to stable from negative. The country is now three notches below investment grade. Just as S&P did in the previous month, Fitch highlighted headwinds against the fiscal adjustment and the expected intensification of political uncertainties during 2018.

Military intervention is declared for public safety in Rio de Janeiro

President Michel Temer declared a military intervention in public safety in Rio de Janeiro. The Constitution establishes that federal interventions prevent the approval of constitutional amendments, so that voting the pension reform is not feasible. The government, which apparently did not have enough votes to approve it even before the intervention, formally announced that it will not try to push the pension reform through Congress in the short term.

Industrial production sustains an upward trend in December

Industrial production advanced 2.8% mom/sa in December, beating the median of market expectations. In 2017, the indicator expanded 2.5%, its fastest growth pace since 2010. Indicators related to gross fixed capital formation remain consistent with growth in this demand component. Production of capital goods was stable at the margin (after seven consecutive increases) and production of construction material climbed 5.0% during the month and 7.2% yoy. Available coincident indicators (industrial confidence, capacity utilization, weekly foreign trade figures, power consumption, auto sector data, among others) point to a 2.1% drop in industrial production in January. Importantly, the upward trend (assessed by the 3-month moving average) would be sustained if such drop is confirmed.

Retail sales increase 2% in 2017

Retail sales dropped 1.5% mom/sa in December, disappointing the median of market expectations. In 2017, sales expanded 2.0%, after falling 6.3% in 2016. Weakness was widespread across segments in December, but those more influenced by store promotions (furniture and appliances; personal items) were particularly relevant, reinforcing the importance of the Black Friday event in explaining the result.

Service sector revenues rise for a second straight month

Real revenues from services climbed 1.3% mom/sa in December, marking a second consecutive increase. Growth was not widespread (only 7 out of 12 activities posted gains), but reinforces our view that the service sector is tracking the overall recovery in economic activity.

GDP grows 1.0% in 2017

GDP increased 0.1% in 4Q17, in line with our call and below market estimates (0.3%). Hence, the economy grew 1.0% in 2017, after shrinking 3.5% in 2016. The agricultural sector posted a robust 13% advance. Furthermore, 4Q17 figures showed that consumption and investment continue to expand.

Inflation remains low, with a good composition

The mid-month consumer price index IPCA-15 climbed 0.38% in February, close to market expectations, driving the year-over-year change to 2.86%. Service inflation continues to recede, especially due to high unemployment and lower inertia from past inflation. For the full year, our estimate for the headline IPCA is 3.5%, thus below the Central Bank’s 4.5% target.

Primary budget surplus reaches 31 billion reais in January

The central government posted a surplus of 31 billion reais in January, boosted by strong tax revenues, at 155.6 billion reais, or 10.7% more than one year earlier in real terms. Tax amnesty program REFIS provided a noteworthy contribution of 7.8 billion reais during the month. These readings indicate that the government is very likely to meet this year’s fiscal target.

Financial assets 

In February, the Ibovespa dropped 2.0% in dollars and rose 0.5% in local currency. Country risk measured by the 5-year CDS increased and ended the month at 156 bps. The exchange rate weakened to 3.24 reais per dollar.

Upcoming events

The Central Bank’s Monetary Policy Committee (Copom) meets on March 21 and may interrupt the easing cycle or decide in favor of an additional 25bp-cut in the benchmark rate to 6.50%. News on the presidential election will also be closely monitored, as the deadline for presidential candidates to join political parties looms in early April.



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