Itaú BBA - Copom: low for long reinforced

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Copom: low for long reinforced

December 12, 2018

The statement brought important changes, all on the benign side for prospective inflation

The Copom decided to leave the base rate unchanged at 6.5% pa, as widely expected. But the statement brought important changes, all on the benign side for prospective inflation. First, the authorities’ forecasts in the baseline scenario, with a constant Selic rate at 6.5% pa and the exchange rate at 3.85 BRL/USD, are fully consistent with the targeted path in longer horizons: 3.7% for 2018 (versus a 4.5% target), 4.0% for 2019 (vs. 4.25%), and 4.0% for 2020 (vs. 4.0%). Second, in the committee’s eyes, the risk of a lower-than-expected path for inflation due to high spare capacity has increased, while the risk of frustration with the continuation of reforms and adjustments has diminished. Finally, the change in forecasts and risks seem to have been significant enough as to cause the Copom to remove the mention of a gradual stimulus removal in case of deterioration of the inflation outlook and balance of risks. By and large, the statement is consistent with the view of low interest rates for long in Brazil, and our own forecast of stable Selic rate at 6.5% pa throughout 2019. We will learn more about the Copom´s thinking with the release of the meeting minutes on Tuesday, December 18, at 08:00am Brazil time.
 

Details

In the statement, the committee assessed that recent economic activity data continues to show a gradual recovery of the Brazilian economy. 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.

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

Inflation expectations reported by the Focus survey fell to 3.7% from 4.4% in 2018 and to 4.1% from 4.2% in 2019. Expectations for 2020 are around the 4.0% and 3.75% targets, respectively. 

The Copom’s own forecasts in the scenario with constant interest rates at 6.50% and constant exchange rate at 3.85 BRL (average of the five working days up to the Friday that preceded the Copom meeting) retreated to 3.7% for 2018 and 4.0% for 2019 and 2020 (from 4.4%, 4.2% and 4.1%, respectively). In the scenario with the interest and exchange rates reported by the Focus survey, Copom’s forecasts are around 3.7% for 2018, 3.9% for 2019 and 3.6% for 2020 (against 4.4%, 4.2% and 3.7%, respectively). This scenario assumes interest rates that end 2018 at 6.50%, 2019 at 7.5% and reach 8.0% in 2020, in addition to an exchange rate at 3.78 BRL in 2018 and 3.80 BRL in 2019 and 2020.

The Copom presents the same risks around its baseline scenario for inflation, but evaluates that these sources of pressure have changed in intensity. For the committee, the risk arising from high 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. The external risk of a deterioration of the environment for emerging economies also remains in sight. In re-weighing these factors, the Copom avoided an explicit mention to the degree of (as)symmetry of the balance of risks, as has been the case in previous reports.

The Copom reiterated that the economic scenario prescribes stimulative monetary policy – that is, with interest rates below the structural rate. It also repeated that the continuity of the necessary reforms and adjustments in the Brazilian economy is essential for the maintenance of low inflation in the medium and long term. However, in line with the assessment of lower domestic risks, they removed the indication that the present stimulus can be gradually withdrawn, if the prospective scenario for inflation in the monetary policy relevant horizon and/or its risk balance deteriorate.

Therefore, the Copom decided to leave the base rate unchanged at 6.5% pa, as widely expected. But the statement brought important changes, all on the benign side for prospective inflation. First, the authorities’ forecasts in the baseline scenario, with a constant Selic rate at 6.5% pa and the exchange rate at 3.85 BRL/USD, are fully consistent with the targeted path in longer horizons: 3.7% for 2018 (versus a 4.5% target), 4.0% for 2019 (vs. 4.25%), and 4.0% for 2020 (vs. 4.0%). Second, in the committee’s eyes, the risk of a lower-than-expected path for inflation due to high spare capacity has increased, while the risk of frustration with the continuation of reforms and adjustments has diminished. Finally, the change in forecasts and risks seem to have been significant enough as to cause the Copom to remove the mention of a gradual stimulus removal in case of deterioration of the inflation outlook and balance of risks. By and large, the statement is consistent with the view of low interest rates for long in Brazil, and our own forecast of stable Selic rate at 6.5% pa throughout 2019. We will learn more about the Copom´s thinking with the release of the meeting minutes on Tuesday, December 18, at 08:00am Brazil time.



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