Itaú BBA - Copom frontloads the easing cycle

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Copom frontloads the easing cycle

February 1, 2017

The Committee justified the acceleration based on data revealing weaker economic activity and lower-than-expected inflation.

The Brazilian economy in January 2017

The Central Bank cut interest rates by 75 bps, stepping up the pace of monetary easing. Inflation declined, ending 2016 below the target’s upper bound.  In the fourth quarter, economic activity continued to contract, but data on the margin points towards growth.  In the labor market, unemployment continues to rise.  The BRL appreciated against the dollar again. A fiscal recovery package was announced for Rio de Janeiro but has yet to be approved by legislation.  The fiscal deficit remains high, but the current account deficit fell back for the second consecutive year. Teori Zavascki, a Federal Supreme Court Minister and rapporteur in the Car Wash Operation, died in a tragic aircraft accident. 

The Central Bank cut interest rates by 75 bps, accelerating the pace of monetary easing

The Central Bank’s Monetary Policy Committee (Copom) unanimously decided to make another interest rate cut, this time of 75 bps, surprising the market (which expected a 50 bps cut) and bringing down the Selic benchmark interest rate to 13.00% p.a.  The Committee justified its decision to step up the pace of easing with a 75 bps rate cut based on data revealing weaker economic activity and lower-than-expected inflation.  The minutes of the January meeting showed that all of the BCB’s inflation forecasts for 2017 and 2018 are in line with or below the 4.5% target.  The BCB stated that the acceleration is more consistent with a frontloading of the cycle and that the overall budget of cuts and any future review in the pace of easing “will continue to depend on inflation forecasts, expectations, and the evolution of risk factors”. 

IPCA seals 2016 within the target interval

Inflation remained below market expectations and with widespread decline across all main components.  The National Consumer Price Index (IPCA) ended 2016 up 6.29%, well below the 10.67% seen at the end of 2015 and within the inflation target’s upper bound (6.5%).  Inflation measured by the IPCA-15 (January) extended this trend, slowing to 5.94%. Expectations based on the Central Bank survey continue to evolve positively, falling to 4.70% for 2017 and remaining anchored at the 4.5% target for horizons up to 2018 and beyond. 

Weaker economic activity in the fourth quarter, but some signs of improvement on the margin

Fourth quarter figures still show some weakness in activity, signaling a further drop in GDP over this period.  Service industry revenues were stable in November (0.1%) but failed to recover from the significant drop in October (-2.3%).  Preliminary retail indicators from December suggest weakness, offsetting the November improvement (when consumers probably anticipated purchases due to Black Friday discounts).  In the industrial sector, although the figures also showed weakness in November (a 2.3% drop), indicators reacted positively on the margin, with a 2.3% rise in industrial output in December and a 5.1% boost in business confidence in January.

The labor market continues to close jobs and unemployment remains on the rise

Formal job creation remains negative in the labor market, albeit job losses have moderated recently. In December, there was a net loss of 462,000 formal jobs, which was better than market expectations. The result did not avert a rise in unemployment: the nationwide unemployment rate hit 12.0% in December, representing an increase to 12.6% from 12.3% after stripping out seasonal effects. 

The BRL appreciates against the dollar

The BRL appreciated 4.1% against the dollar in January, reaching BRL 3.13, its lowest level since October last year.  The move was partly driven by a widespread appreciation of global currencies against the dollar, though the BRL outperformed its peers.  The Central Bank continued to rollover FX swaps, but reported that any decision to roll over contracts maturing in March will depend on market conditions.  The stock of FX derivatives currently stands at USD 27 billion.

Rio de Janeiro’s fiscal recovery agreement announced

The federal government and the state of Rio de Janeiro announced a fiscal recovery package for the state.  The program will run for three years (and may be extended if necessary) in an attempt to balance Rio’s deficits between 2017 and 2019 (approximately BRL 20 billion in each year) through a combination of measures involving revenues, expenditures, debt renegotiation and new loans.  The agreement requires the approval of a Supplementary Bill to be sent to Congress, as well as approval of measures by the state’s Legislative Assembly.  On the revenue side, in exchange for federal aid, the program will require a review of tax incentives and a rise in public-sector Social Security contributions.  On the expenditure side, few details were announced but the agreement may include a voluntary layoff program and postponement/cancellation in the payment of delayed expenses.

The fiscal deficit continues to escalate...

In December, the consolidated public sector registered a primary deficit of BRL 70.7 billion, raising the primary deficit to BRL 156 billion in 2016 (-2.5% of GDP from -1.9% in 2015) and the nominal deficit to BRL 563 billion (8.9% of GDP).  In 2016, regional governments registered a primary surplus of BRL 5 billion.  Gross public debt rose to 69.5% in 2016 from 65.5% of GDP in 2015.

...while the current account deficit retreated for the second consecutive year

December 2016’s current account deficit came in at USD 5.9 billion, above market expectations. In 2016, the deficit fell to USD 23.5 billion, or 1.3% of GDP, compared with USD 59 billion or 3.3% of GDP in 2015 - this difference can be explained by currency depreciation (on average) as well as the recession.  Direct investment in the country was once again a positive surprise, totaling USD 78.9 billion (4.4% of GDP) in 2016, and was the current account deficit’s main source of financing.

Supreme Court Minister Teori Zavascki dies in aircraft accident

On January 19, Federal Supreme Court Minister Teori Zavascki died in a tragic aircraft accident just off the coast of the state of Rio de Janeiro.  Zavascki took his seat in the Supreme Court in November 2012 and was the rapporteur in charge of the Car Wash Operation.  A new rapporteur for the case and a replacement for his seat in the Supreme Court are yet to be decided.

Financial assets appreciate once again

The Ibovespa Index was up 11.9% in dollars and 7.4% in BRL while country risk, measured by the 5-year sovereign CDS, fell 30 bps and ended the month at 251 bps.

Upcoming events

Elections for Lower House and Senate leaders will be held on February 2nd.  Congress will resume activities on the government’s Social Security reform proposal.  Negotiations concerning the states’ fiscal situation will continue. The Copom will meet on February 22 to decide on the benchmark rate of interest (we expect a 75 bps cut).


 

 



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