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COPOM Minutes: Comfortable with Selic rate at 6.5% p.a.

December 18, 2018

The minutes reinforce the outlook that the Selic rate will hibernate at the current level for quite some time, barring significant shocks

The Copom minutes surprised by reintroducing the assessment of an asymmetric balance of risks, with upside inflation risks prevailing, even if recognizing these are less intense than previously thought. The Copom also discussed the recent drop in inflation forecasts and assessed the level of underlying inflation measures, concluding that the projections are still consistent with the convergence of inflation towards its targets in 2019 and 2020. All in all, this reinforces the outlook that the Selic rate will hibernate at the current level of 6.5% pa for quite some time, barring any significant shocks. We expect policy normalization will only begin sometime in 2020. 
 

Recent economic developments and the baseline scenario

As already stated in the post-meeting communiqué, the Copom understands that recent economic activity indicators continue to show a gradual recovery in Brazil. The external scenario is still assessed as challenging for emerging economies, with risks associated with increased risk aversion in international markets, normalization of interest rates in advanced economies, and uncertainties about global trade.

According to the committee, several underlying inflation measures remain at appropriate or comfortable levels, including the components that are most sensitive to the economic cycle and monetary policy.

The text then outlines the Copom's main assumptions and forecasts. Considering the expectations reported in the Focus survey for the BRL and interest rates, the Copom’s forecasts are around 3.7% for 2018, 3.9% for 2019 and 3.6% for 2020 (from 4.4%, 4.2% and 3.7%, respectively). This scenario assumes interest rates that end 2018 at 6.5%, 2019 at 7.5% and reach 8.0% in 2020, in addition to BRL at 3.78 in 2018, 3.80 in 2019 and 2020. The regulated price inflation forecasts in this scenario are 6.1% for 2018, 5.1% for 2019 and 3.9% for 2020. In the reference scenario, with constant interest rates at 6.5% pa and a constant BRL at 3.85, the Copom's  forecasts for inflation retreated to 3.7% for 2018, 4.0% for 2019 and 2020 (from 4.4%, 4.2% and 4.1%, respectively). In this scenario, the forecasts for regulated price inflation are 6.1% for 2018, 5.2% for 2019 and 4.0% for 2020.

Risks

In discussing the risks for inflation, the Copom mentioned (as in the post-meeting statement) that the main sources of pressure have changed in intensity. The committee assessed that downside risks arising from high slack have increased, while the upside risks regarding the frustration of expectations about the continuity of reforms  have diminished. However, in contrast with the post-meeting statement – in which the Copom avoided explicit mentions to the degree of (a)symmetry in the balance of risks – they emphasize in the minutes that the upside risks are still significant and have a higher weight in their evaluation. As a result, they conclude that the balance of risks remains asymmetric, even if by a lesser degree than before.

Policy discussion

In paragraph 12, the Copom discussed the evolution of economic activity and concluded that recent data indicates continuation of the recovery process in Brazil, in a gradual pace.

About global landscape, in paragraph 13 the Copom considers that the scenario remains challenging for emerging economies. The committee also noted that prices of risky assets remain volatile and discussed the possible negative effects of increased risk aversion in international markets. The Copom’s baseline scenario contemplates the gradual normalization of monetary policy in key countries. Again, the committee acknowledged the uncertainty associated with international trade, with potential impacts on global growth and, in particular, on the Chinese economy. Finally, the Copom once again highlighted Brazil’s ability to absorb the environment deterioration, given its robust balance of payments, low inflation in the recent past, with anchored expectations, and the outlook of economic recovery.

At the domestic level, paragraph 14 mentions that the committee discussed the recent drop in inflation forecasts and the measures of underlying inflation, concluding that these are at appropriate or comfortable levels and that the forecasts indicate inflation convergence towards the targets in 2019 and 2020. Moreover, the committee pointed out that such path is consistent with inflation expectations, which remain anchored. That said, the Copom once again assessed that the risks to the consolidation of this scenario in the medium and long term are mainly related to the progress of reforms and adjustments necessary to the Brazilian economy.

In paragraph 15, the Copom presents the same risks around its baseline scenario for inflation, but, as in the meeting statement, it considers that these sources of pressure have changed in intensity. The committee assessed that the risk arising from high economic slack, which may lead to a lower-than-expected trajectory for prospective inflation, has increased, while the risk of frustration of expectations about the continuity of reforms – which may affect risk premia and cause a deterioration in the inflation path – has diminished. Externally, there remains the risk of a deterioration in the environment for emerging markets. However, in contrast with the post-meeting statement, the committee did not refrain from evaluating the asymmetry of the balance of risks, highlighting in the minutes that the upside risks to inflation remain relevant and still have greater weight. In sum, the Copom concluded that the asymmetry in the balance of risks for inflation persists, although with less intensity now.

Regarding the convenience of signaling their next steps, paragraph 20 shows that, despite the lower degree of asymmetry in the balance of risks, all committee members agree that the current conjuncture makes it appropriate to maintain greater flexibility in monetary policy. This means refraining from giving any indication about their next steps. In this context, committee members stressed the importance of emphasizing their commitment to conduct monetary policy with the goal of keeping the inflation path consistent with the targets. However, the Copom removed from this paragraph the reference, present in previous documents, to the need of having flexibility to gradually adjust monetary policy if and when necessary.

The Committee further noted in paragraph 22 that caution, serenity, and perseverance in monetary policy – including in volatile environments – have been useful in pursuing the goal of maintaining the inflation path around the targets and are good principles for guiding its decisions.

Policy decision

According to the committee, the decision to keep the policy rate stable is consistent with the convergence of inflation towards the target within the relevant policy horizon, which includes 2019 and, to a lesser extent, 2020. The Copom repeated that the economic scenario calls for stimulative monetary policy (lower-than-neutral rates), but also maintained the warning that the continuity of reforms and adjustments in the Brazilian economy is essential for the sustainability of low inflation in the medium and long term. However, reflecting the assessment of lower domestic risks – and in line with the changes made in the post-meeting statement – they removed the indication that the present stimulus can be withdrawn if the prospective scenario for inflation and/or its risk balance deteriorate.

Interpretation

Therefore, the Copom minutes surprised by reintroducing the assessment of an asymmetric balance of risks, with upside inflation risks prevailing, even if recognizing these are less intense than previously thought. The Copom also discussed the recent drop in inflation forecasts and assessed the level of underlying inflation measures, concluding that the projections are still consistent with the convergence of inflation towards its targets in 2019 and 2020. All in all, this reinforces the outlook that the Selic rate will hibernate at the current level of 6.5% pa for quite some time, barring any significant shocks – we expect policy normalization will only begin sometime in 2020.



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