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COPOM Minutes: easing ahead, probably

June 25, 2019

The minutes reinforce our call that the Copom will resume easing in July, conditional on concrete progress in the reform front.

• The Copom minutes bring about a clear verbal indication that, conditional on concrete progress on the reform front, the Copom will resume easing shortly. This comes in paragraph 17, in which the authorities state that the forward looking scenario that incorporates rate cuts delivers inflation at target in the key policy horizon. The text also updates their assessment of economic activity, with explicit concession that the recovery has stalled. While expressing a more benign assessment of the external environment, the Copom provides a mixed view on the impact of fiscal adjustment on the economy. In all, we think the text reinforces our call that the Copom resumes easing with a 25-bp rate cut in its July 30-31st meeting, conditional on concrete progress in the reform front. It should be noted that the Copom decision will take place a few hours after the release of the July FOMC outcome, which may have some bearing on local deliberations.

Recent economic developments and the baseline scenario

Following the change implemented in the post-meeting communiqué, the Copom revised its assessment of the current economic scenario, stating that recent activity indicators suggest the recovery of the Brazilian economy has stalled in recent quarters (at May’s meeting, the recovery process was described as losing momentum; at March’s, it was described as gradual). Nevertheless, the committee kept the message that, despite this interruption, its baseline scenario contemplates a gradual rebound ahead.

Regarding the external environment, the Copom now assesses that the scenario is less adverse (previously, the international scenario was described as challenging), due to changes in the outlook for monetary policies in main economies. However, risks associated with a global deceleration remain as a source of pressure.

The committee assesses that underlying inflation measures are at proper levels, including the components most sensitive to the economic cycle and monetary policy.

Considering the expectations reported in the Focus survey for exchange and interest, Copom's inflation forecasts for 2019 declined to 3.6% (from 4.1%) and increased to 3.9% in 2020 (from 3.8%). This scenario assumes an interest trajectory that ends 2019 at 5.75% and reaches 6.50% in 2020, in addition to an exchange rate ending 2019 and 2020 at BRL/USD 3.80. Forecasts for regulated price inflation receded to 3.9% in 2019 and 4.6% in 2020 (versus 5.3% and 5.0%, respectively). In the reference scenario, with constant interest rate at 6.50% and exchange rate at BRL/USD 3.85, the inflation forecasts fell to 3.6% in 2019 (from 4.3%) and 3.7% in 2020 (from 4.0%). In this scenario, forecasts for regulated price inflation dropped to 3.9% for 2019 (versus 5.6%) and 4.6% for 2020 (from 5.1%).

Risks 

The committee continues to describe the balance of risks as symmetrical, but they affirm that it has evolved favorably (as in the post-meeting statement). Regarding the factors that are commonly discussed in its communication, the Copom did not change their assessment about the downside risks arising from spare capacity in the economy or the risks of a deterioration in the environment for emerging economies. They highlighted the risk associated with a possible frustration of expectations about the continuity of the reforms and the necessary adjustments in the Brazilian economy, stating that, at this juncture, it is the most important factor in its evaluation.

Policy discussion

In paragraph 12, the Copom assessed the recent evolution of economic activity and concluded, as it had already said in the post-meeting communiqué, that the recovery of the Brazilian economy has stalled. According to the committee, this interruption is clear when looking at a slightly longer period, suggesting a change of dynamics after the second quarter of 2018, with a loss of momentum in the gradual recovery that had been taking place until then. The Copom also expects that GDP is likely to remain broadly stable in the 2Q19, after falling in the first quarter.

Still on economic activity, in paragraph 13, the members of the committee evaluated that the effects of the shocks suffered by the Brazilian economy in 2018 have largely faded, and that the financial conditions returned to a more stimulating level after the tightening seen in 2018. Thus, their baseline scenario contemplates a gradual recovery of the economy ahead.

In paragraph 14, the minutes mention the debate among Copom members on the factors that could constrain economic growth, in a context of deep and necessary adjustments, especially of fiscal nature. The committee reiterates the view that uncertainties about fiscal sustainability tends to be contractionary, especially due to their impact on investment decisions. With limited room for public investments, the Copom emphasized the importance of reforms that create a sustainable fiscal trajectory. By lowering uncertainties, these reforms tend to stimulate private investment and offset, to some extent, the short-term impacts of the fiscal adjustment on economic activity.

Regarding the international environment, paragraph 16 shows that the committee sees a less adverse scenario, with signs that the key central banks are willing to provide additional monetary stimuli, if necessary, thereby contributing to the loosening of global financial conditions. In spite of that, Copom members see that risks associated with a global slowdown remain, and uncertainties about economic and geopolitical policies can contribute to even lower global growth. Faced with evidence of economic slowdown in several countries, some committee members noted that the global environment may be more relevant than anticipated for economic activity in Brazil.

In paragraph 17, the Copom discusses recent inflation forecasts and underlying inflation measures. The latter are at appropriate levels, according to the committee. On the short-term estimates, the Copom pointed out that the retreat of food inflation and recent oscillations in fuel and electricity prices tend to produce lower inflation than previously expected, explaining a substantial part of the drop in the conditional forecasts for 2019 inflation.

Still, in what we see as one of the main highlights in these minutes, the committee emphasized that the scenarios with constant interest rates produce inflation a little below target for 2020, while the scenarios with the interest rate path reported by the Focus survey – which incorporate additional easing – produce inflation around the target.

Paragraph 18 mentions the debate among Copom members on the evolution, since the previous meeting, of the factors highlighted in the balance of risks for the inflation’s baseline scenario. All members agreed that the balance of risks evolved favorably, but stressed that the consolidation of the benign scenario reflected in the inflation expectations and in the central bank’s conditional forecasts depends on the progress of the necessary reforms and adjustments, which are fundamental to maintain the environment of anchored inflation expectations. A potential frustration of this outlook may affect risk premia and raise inflation rates in the horizon relevant to monetary policy. Thus, it is the predominant factor in the balance of risks for inflation at this moment. 

In paragraph 19, the Copom introduces a deeper discussion on the structural interest rate, noting that it is a non-observable variable whose estimates involve a high degree of uncertainty. That said, the committee understands that current ex-ante real interest rates have a stimulating effect on the economy, as they should at the moment, and that this evaluation is not inconsistent with the weaker-than-expected economic performance, since there are several other factors that affect the economy.

In paragraph 22, the Copom reaffirms that it considers important to observe the behavior of the Brazilian economy over time, under lower uncertainty than what it is still exposed today. 

Finally, in paragraph 24, the committee reiterates its view that the continuity of the process of necessary reforms and adjustments in the Brazilian economy is essential for the equilibrium interest rate to drop, for the proper functioning of monetary policy and for the sustainable recovery of the economy. In particular, the Copom believes that concrete advances in the reform agenda are fundamental to consolidating the benign scenario for prospective inflation.

Policy decision

The Copom affirmed once more that the economic scenario calls for stimulative monetary policy (lower-than-neutral rates). The committee also stated that it is important to observe the behavior of the Brazilian economy over time, with reduction in the degree of uncertainty to which it is still exposed. However, we believe that the Copom has paved the way to cut rates already in the next meeting – if conditions allow – by removing the statement (which was present in previous pieces of communication) that this evaluation is time-consuming and should not be completed in the short term. In addition to that, the committee noted again that concrete progress on the reform agenda is essential to a consolidation of the benign scenario for prospective inflation.

Interpretation

Therefore, Copom minutes bring about a clear verbal indication that, conditional on concrete progress on the reform front, the Copom will resume easing shortly. This comes in paragraph 17, in which the authorities state that the forward looking scenario that incorporates rate cuts delivers inflation at target in the key policy horizon. The text also updates their assessment of economic activity, with explicit concession that the recovery has stalled. While expressing a more benign assessment of the external environment, the Copom provides a mixed view on the impact of fiscal adjustment on the economy. In all, we think the text reinforces our call that the Copom resumes easing with a 25-bp rate cut in its July 30-31st meeting, conditional on concrete progress in the reform front. It should be noted that the Copom decision will take place a few hours after the release of the July FOMC outcome, which may have some bearing on local deliberations.



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