Itaú BBA - Copom Minutes: is the end coming?

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Copom Minutes: is the end coming?

October 31, 2017

We keep, for now, our call that the end will only come in February, with a final 50bps rate cut, taking the Selic to 6.5%pa.

The minutes from the Central Bank’s Monetary Policy Committee (Copom) September meeting confirmed the message, presented in the statement, that the base case for now is a 50bps cut in December, provided current economic conditions, namely recovery of economic activity amidst wide slack, especially in the labour market, remain unchanged. The committee goes out of its way, in paragraph 24 of the minutes, to signal that it has yet to make up its mind on subsequent decisions, leaving the door fully open to a final rate cut in February (we thus still see the cycle ending with the Selic at 6.5%). 
 

Recent economic developments and the baseline scenario

The batch of economic data released since the last policy meeting in September remains consistent with gradual recovery of economic activity. The economy is still working with ample slack, as shown by capacity utilization indices and, specially, the unemployment rate.

The external environment is favorable, with a gradual economic recovery that has not exerted excessive pressure (the adjective is new) on financial conditions in advanced economies. This has contributed to support appetite for risk assets in emerging markets. 

Inflation is deemed to have behaved as expected. Price dynamics have remained favorable (previously quite favorable), with several core indices at comfortable (previously low) levels, including in components more sensitive to the economic cycle and monetary policy. 

The text then outlines the Copom’s key assumptions and forecasts. Within the former, the note cites the expectations for regulated prices, 7.9% (up from 7.5%) for 2017, and 5.1% (down from 5.2%) for 2018, and 4.3% for 2019. Its inflation forecasts under market interest rate and exchange rate assumptions stood at 3.3% for 2017, and 4.3% (down from 4.4%) for 2018, with the base rate at 7.0% pa (previously 8.0% pa) in year-end 2017 and in 2018, rising to 8.0% during 2019, suggesting stability of the forward looking scenario.

Risks

The Copom envisages downward and upward risks to the basic inflation scenario. The committee notes that the economy faces favorable and unfavorable price shocks. The former relate to falling food prices, while the latter are due to rising energy costs. And the authorities signal that they will fight second-round effects of said shocks, in a symmetric way. Additional risks refer to the implementation of necessary adjustments (read fiscal) and a reversal of currently favorable external financial conditions. 

Policy discussion

The text notes, in paragraph 12, that available evidence confirms the gradual recovery of economic activity. The committee also notes that there are signs of a recovery in employment even at the current stage of the cycle (something that has also puzzled analysts outside the central bank). Copom members have debated recent, somewhat soft, activity data, but also the chances of a stronger rebound going forward, and conclude that, with the currently (wide) level of slack, these short-term fluctuations are unlikely to lead to material shifts in prospective inflation. 

Paragraph 13 repeats the assessment that the external environment is favorable, with a gradual recovery, that has failed to exert excessive pressure on financial conditions. Members noted that while global financial conditions have become somewhat less expansionary, as yet the impact on emerging economies has been limited. 

In paragraphs  15 and 16 the Copom faces head on the issues in the energy sector, that may well configure a negative supply shock, which is already (direct impact) embedded in its forecasts. The committee restates that it will fight the second-round effects of the supply shock, in a approach that is similar to that taken on the (benign) food price shock. 

The key messages in the text, in paragraphs 23 and 24, indicate that a moderate reduction in the pace of easing was appropriate but, quite explicitly, refrain from extending guidelines into the new year, thereby leaving the door open to a continuation of the easing cycle in the February Copom meeting – the committee states that it wants to keep its freedom of action, so as to be able to take into account new information pertaining to the basic scenario as well as the balance of risks (including, of course, information on the progress, or lack thereof, in the reforms front).

Policy decision

The Committee states that, considering the basic scenario and balance of risks, a 75bps rate cut is consistent with inflation convergence to the target in the relevant policy horizon. In paragraph 29, the committee notes again that the economic juncture warrants sub-structural (or neutral) interest rates. Looking forward, in paragraph 31 the Copom indicates that, under the basic scenario, a moderate reduction of the pace in the next policy meeting (to 50bps) seems, at the moment, adequate. 

Interpretation

The minutes outline a flight path for the Selic on its way to 7.0% by year-end. The February decision is purposefully left wide open. This suggests that the authorities may consider, given the magnitude of estimated economic slack and the balance of risks around the basic scenario, that a little more stimulus than currently priced in may be appropriate. We thus keep, for now, our call that the end will only come in February, with a final 50bps rate cut, taking the Selic to 6.5%pa. 



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