Itaú BBA - COPOM Minutes: Selic rate to remain stable in September, in the absence of new shocks

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COPOM Minutes: Selic rate to remain stable in September, in the absence of new shocks

August 7, 2018

Copom minutes signal stable policy rate at 6.50% in its next meeting.

The Copom minutes indicate that, in the absence of additional shocks, the inflationary scenario should be comfortable, or in other words consistent with the inflation targets. This suggests that the base-case is to keep the policy rate stable at 6.5% in the next meeting to be held in September, although the committee stated explicitly that no forward guidance is being provided, given the higher level of uncertainty currently observed in the scenario. The Copom also discussed conditionalities that may influence the adequate magnitude of stimulus – namely, inflation expectations, spare capacity in the economy, the balance of risks, and inflation forecasts – suggesting the committee may eventually change the monetary policy stance, to one side or the other, as these factors evolve.
 

Recent economic developments and the baseline scenario

According to the Copom, recent economic activity data reflect the effects of the truckers’ stoppage, but there is already evidence of recovery. The base-case scenario remains consistent with an ongoing activity recovery, in a more gradual pace than expected before the stoppage. The external scenario presented some accommodation recently, but remains challenging. The main risks are associated with the normalization of interest rates in advanced economies and uncertainty about global trade.

June’s inflation reflected significant upward effects from the truckers’ stoppage and other relative price adjustments, but recent data reinforce the view that these effects should be only temporary. Measures of core inflation remain at low levels, including the components that are more sensitive to monetary policy (that is, service prices).

The text then outlines the Copom’s key assumptions and forecasts. Considering interest rate and exchange rate expectations reported in the Focus survey, the committee’s estimates inflation around 4.2% for 2018 and 3.8% for 2019. This scenario assumes, among other hypotheses, interest rate trajectory ending 2018 at 6.50% p.a. and 2019 at 8.0% p.a., and the exchange rate at 3.70 reais per U.S. dollar by YE18 and YE19.

In the scenario with the benchmark interest rate constant at 6.50%, and the exchange rate constant at 3.75 reais per U.S. dollar, its inflation forecast hovers around 4.2% for 2018 and 4.1% for 2019.

Risks

The Copom continues to envisage downside and upside risks to the basic inflation scenario. On one hand, the possible propagation, throught inertial mechanisms, of the low level of past inflation and the still wide economic slack can produce a lower-than-expected inflation going forward. On the other hand, there are also upside risks, which according to Copom remain at higher levels: disappointing expectations about the reform agenda and necessary adjustments in the economy, which would affect risk premia and increase the inflation trajectory, and the deterioration of the external scenario for emerging market economies.

Policy discussion

In paragraph 11, the Copom discussed the recent economic activity evolution. The committee recognizes that data for May were influenced by the truckers’ stoppage, but concludes that more recent data signal a subsequent rebound, even with some data for June possibly also affected by the event.

Regarding the global context, paragraph 12 shows that the committee evaluates that the scenario remains challenging, although there was some accommodation in global financial conditions recently. The Copom’s base case continues to be one of gradual normalization of monetary policy in central economies, with risks of a stronger impact of this process on emerging economies, which may reinforce the adjustment in relative prices (read: exchange rate) and volatile financial conditions. The higher risks surrounding global trade expansion, with possible impacts on global growth, were mentioned again. In this context, the committee highlighted again the capacity of the Brazilian economy to absorb the deteriorating global scenario, given the robust situation in the balance of payments, 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 inflationary scenario. There is a consensus within the Copom that inflation for June reflected upside effects from the truckers’ stoppage and other relative price adjustments, but forecasts for July and August indicate that these shocks will be temporary. The committee highlights that core inflation measures were at low levels before these shocks and that changes in relative prices, in a context of anchored inflation expectations, may contribute to the convergence of inflation towards the target, without risk for the favorable dynamic after these adjustments are concluded. However, possible impacts from the shocks that are more permanent must be evaluated, according to the Copom, through the monitoring of prospective inflation in longer horizons, and the anchoring of inflation expectations.

Paragraphs 15 and 16 discuss the potential impact of the exchange rate on monetary policy, without introducing novelties in relation to previous meetings. In particular, with anchored expectations, only secondary effects should be addressed by the Copom. In addition, 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 be anchored. The committee discussed again the degree of exchange rate pass-through in the Brazilian economy and, given its various determinants (for example, the level of excess capacity in the economy and the anchoring of expectations), reiterated that it will follow different measures of it, both for inflation and for underlying inflation.

After restating, in paragraph 17, the understanding that current ex-ante real interest rates have a expansionary effect on the economy, the committee discussed, in paragraph 18, the conditionalities that may influence the adequate magnitude of stimulus – namely, inflation expectations, spare capacity in the economy, the balance of risks, and inflation forecasts – suggesting the committee may eventually change the monetary policy stance, to one side or the other, as these factors evolve.

Regarding the evolution of the basic scenario, the committee pointed out in paragraph 20 that the truckers' stoppage is having a temporary effect on the economy, but paragraph 21 reinforces the committee's view on the need to monitor and assess the perpetuation of the effects of these shocks on inflation. On the balance of risks for the prospective inflation trajectory, paragraph 22 shows that the Copom continues to evaluate that the downside risk resulting from the low level of inflation in recent past has decreased. However, the committee added that such a downside risk is still present given the high degree of spare capacity in the economy. Once again, the Copom discussed the importance of the continuity of the adjustment and reform process in the Brazilian economy to mitigate risks of deterioration of the external scenario. The committee assessed that the latter risks remain at higher levels, as already mentioned in the statement of the meeting.

Paragraph 24 highlights that, in the absence of further shocks, the inflationary scenario should be comfortable. Despite this, the greater level of uncertainty of the current situation generates the need of greater flexibility for monetary policy and recommends abstaining from indications regarding the next steps of monetary policy.

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. The Copom indicated that the evolution of the baseline scenario and the balance of risks makes it adequate to maintain the benchmark rate at the current level, stressing that the next monetary policy steps will continue to depend on the evolution of economic activity, the balance of risks, and inflation forecasts and expectations.

Interpretation

The Copom minutes indicate that, in the absence of additional shocks, the inflationary scenario should be comfortable, or in other words consistent with the inflation targets. This suggests that the base-case is to keep the policy rate stable at 6.5% in the next meeting to be held in September, although the committee stated explicitly that no forward guidance is being provided, given the higher level of uncertainty currently observed in the scenario. The Copom also discussed conditionalities that may influence the adequate magnitude of stimulus – namely, inflation expectations, spare capacity in the economy, the balance of risks, and inflation forecasts – suggesting the committee may eventually change the monetary policy stance, to one side or the other, as these factors evolve.



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