Itaú BBA - COPOM Minutes: ready to act

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COPOM Minutes: ready to act

September 25, 2018

Faced with a balance of risks that is tilted towards higher inflation, the Copom stands ready to act.

The Copom meeting minutes make it clear that, faced with a balance of risks that is tilted towards higher, rather than lower, inflation, its members stand ready to act. A gradual Selic rate hike would follow from additional worsening of inflation expectations and/or of the balance of risks thereto. While the committee notes that the economy still operates with wide slack, it expresses concern with possible second round effects of currency depreciation, and appears to be closely monitoring inflation expectations. For now we expect the Copom to leave rates unchanged at 6.5% pa in October, but we do recognize that the scenario is changeable, and may revisit this call as new developments on the inflation scenario unfold.
 

Recent economic developments and the baseline scenario

According to the Copom, recent economic activity indicators show a more gradual recovery than that seen at the beginning of the year.

The external scenario remains challenging, with lower risk appetite for emerging-market assets. The main risks are still those associated with the normalization of interest rates in advanced economies and the uncertainties about global trade.

According to the committee, several underlying inflation measures are now at appropriate levels (no longer low levels, as described in the minutes of the previous meeting), including the components that are most sensitive to the economic cycle and monetary policy (that is, service prices).

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 4.1% for 2018 and 4.0% for 2019. This scenario assumes, among other hypotheses, interest rates that end 2018 at 6.5% and 2019 at 8.0% and a BRL that ends 2018 and 2019 at 3.83 and 3.75, respectively. The regulated price inflation forecasts used in this scenario are 7.7% for 2018 and 5.4% for 2019. In the scenario with constant interest rates at 6.50% pa and a constant exchange rate at 4.15, the Copom's  forecasts for inflation are around 4.4% for 2018 and 4.5% for 2019. In this scenario, the forecasts for regulated prices inflation are 8.3% for 2018 and 5.7% for 2019.

Risks

The Copom now describes the inflationary balance of risks as asymmetric. On the one hand, wide slack in the economy continues to be a source of downside pressure on prospective inflation, but the downward risk arising from the propagation of low inflation levels has dissipated. On the other hand, the upside risks – related to the frustration of expectations about the continuity of reforms in the domestic economy and to a deteriorating external scenario for emerging economies – have increased.

Policy discussion

In paragraph 11, the Copom discussed the recent evolution of economic activity. After the impact of the truckers’ stoppage, indicators point to the continuity of the economic recovery process. The committee's scenario contemplates continuity of the recovery, at a more gradual pace than anticipated at the beginning of the year.

On the international environment, in paragraph 12 the committee assesses that the scenario remains challenging for emerging economies. The Copom’s base case continues to be one of gradual normalization of monetary policy in central economies. The text also mentioned again the intensification of risks regarding international trade, with possible impacts on global growth. In this context, the committee once again highlighted the Brazilian economy's ability to absorb external setbacks, given the robust balance of payments situation, low inflation in the recent past with anchored expectations and the prospect of an economic activity recovery.

In paragraphs 13 and 14, the committee discusses the scenario for inflation. There is consensus within the Copom that inflation in July and August and the forecasts for the following months reinforce the view that the effects of May’s trucker’s stoppage were temporary. The committee pointed out that several measures of underlying inflation have risen and are at appropriate levels – that is, levels consistent with inflation targets. According to the Copom, it is possible that the recent adjustments in relative prices (exchange rate) contributed to bring inflation to the current target-compatible levels. However, in the context of anchored expectations, this movement does not seem to constitute a risk for the maintenance of such levels. In order to assess whether such shocks could have a longer-lasting impact, the committee members reinforced the importance of monitoring the prospective inflation path and expectations.

Paragraphs 15 and 16 discuss the potential impact of the exchange rate on monetary policy, without bringing significant changes relative to previous communications. In particular, with anchored expectations, only side- effects should be addressed by the Copom. In addition to that, the committee stresses that the possible reaction to relative price changes will be symmetric (it will follow the same principles for inflationary and disinflationary shocks), but emphasizes that this prescription requires that inflation expectations are well-anchored. The committee discussed again the degree of exchange rate pass-through in the Brazilian economy and assessed that, with the exception of some regulated prices, contagion is being contained. Given the various determinants of the pass-through (for example, the level of slack in the economy and the anchoring of expectations), the Copom reaffirmed that it will continue to track different measures of it, both for inflation and for underlying inflation.

After restating, in paragraph 17, the understanding that the economic situation still prescribes stimulative monetary policy, that is, interest rates below the structural rate, the committee discussed, in paragraph 18, the circumstances that can influence the degree of adequate stimulus in the economy – in particular, inflation expectations, economic slack, the balance of risks and inflation forecasts. The Copom pointed out that the provision of monetary stimulus requires anchored inflation expectations and evaluated that this stimulus should be phased out if there is a worsening of the inflation outlook and/or its balance of risks.

Paragraph 21 shows that the Copom began to see the risks around the prospective inflation path as asymmetric, given the increase of the risks regarding the continuity of reforms in Brazil and those associated with a deteriorating environment for emerging economies.

In paragraph 23, members of the committee evaluate that it becomes important to reinforce monetary policy’s commitment to keep the inflation path in line with the targets, which requires flexibility to gradually adjust the policy stance when and if necessary.

Policy decision

According to the committee, the decision to maintain the policy rate stable is consistent with the convergence of inflation towards the target within the relevant policy horizon, and the economic scenario calls for stimulative monetary policy. However, the Copom warns that this stimulus will begin to be gradually withdrawn if the prospective scenario for inflation and/or its balance of risks deteriorate.

Interpretation

The Copom meeting minutes make it clear that, faced with a balance of risks that is tilted towards higher, rather than lower, inflation, its members stand ready to act. A gradual Selic rate hike would follow from additional worsening of inflation expectations and/or of the balance of risks thereto. While the committee notes that the economy still operates with wide slack, it expresses concern with possible second round effects of currency depreciation, and appears to be closely monitoring inflation expectations. For now we expect the Copom to leave rates unchanged at 6.5% pa in October, but we do recognize that the scenario is changeable, and may revisit this call as new developments on the inflation scenario unfold.


 



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