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COPOM Minutes: Steady rates for long

November 6, 2018

Forecasts in line with the targeted path suggest rates may be on course to hibernate for quite some time

The Copom minutes provide a balanced assessment of the economic juncture, highlighting, on the one hand, the challenging external scenario and, on the other, the reduction of domestic uncertainty. The forecasts, that had been presented in the meeting statement, in the baseline scenario, with a constant Selic rate at 6.5% pa, are in line with the targeted path until 2020, suggesting rates may be on course to hibernate at the current level for quite some time – barring unforeseen shocks. Given this backdrop, the Copom will probably leave its base rate unchanged at 6.5% pa in its December 12 policy meeting. 

Recent economic developments and the baseline scenario

According to the Copom, recent economic activity indicators continue to 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 relative to early 2018. 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 remain at appropriate levels, 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 4.4% for 2018, 4.2% for 2019 and 3.7% for 2020. This scenario assumes, among other hypotheses, interest rates that end 2018 at 6.5% and 2019 and 2020 at 8.0% – and a BRL that ends 2018, 2019 and 2020 at 3.71, 3.80 and 3.75, respectively. The regulated price inflation forecasts used in this scenario are 7.4% for 2018, 5.6% for 2019 and 3.9% for 2020. In the scenario with constant interest rates at 6.50% pa and a constant exchange rate at 3.70, the Copom's  forecasts for inflation are around 4.4% for 2018, 4.2% for 2019 and 4.1% for 2020. In this scenario, the forecasts for regulated prices inflation are 7.3% for 2018, 5.4% for 2019 and 4.1% for 2020.

Risks

The Copom states that the inflationary balance of risks became less asymmetric. The wide slack in the economy continues to be seen as a source of downside pressure on prospective inflation. However, the committee points out that they attribute a higher weight to 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.

Policy discussion

In paragraph 11, the Copom discussed the recent evolution of economic activity and concluded that the data indicate continuity of the recovery process of the Brazilian economy, at a more gradual pace than the one envisaged earlier in the year.

On the international environment, paragraph 12 shows that the Copom considers that the scenario remains challenging for emerging economies. But committee members have assessed that since their last meeting there has been a stable risk appetite for assets in these economies, in contrast to the worsening observed in previous months. That said, there was consensus that such stabilization occurred at levels that are lower than those at the beginning of the year, which implies higher risk premia. In addition, since the last meeting, risky assets prices in several advanced economies have been more volatile, in contrast to the favorable evolution observed until then. The Copom’s baseline scenario continues to be a gradual monetary policy normalization in central countries. Again, the intensification of risks regarding international trade, with possible impacts on global growth and on the Chinese economy (for the first time highlighted by the committee) was mentioned. Finally, the Copom once again underscored 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 outlook for economic recovery.

At the domestic level, paragraph 13 highlights the reduction of uncertainties, which produced reduction of risk premia embedded in Brazilian asset prices and, according to the committee, contributed to lower the degree of asymmetry in the balance of risks for inflation. Despite this improvement, Copom members concluded that the upside risks to inflation continue to carry greater weight in their balance of risks.

In paragraphs 14 and 15, the committee discusses the scenario for inflation in more detail. The Copom estimates that inflation in the coming months is expected to peak around the second quarter of 2019 and retreat over the rest of the year toward the target. Regarding underlying inflation, its various measures have risen from levels considered low to levels that the committee deems appropriate – that is, consistent with inflation targets. The Copom considers that the recent adjustments in relative prices (read, exchange rate) seem to have contributed to raising inflation to the current target-compatible figures without constituting risks to the maintenance of inflation at such levels, given the context of anchored expectations. In order to assess the possible longer-lasting impacts of recent shocks, the committee members reinforced the importance of tracking the prospective inflation path and inflation expectations. 

In paragraph 16, it was pointed out that the committee members discussed the adequacy of maintaining in their official communication the message about the operation of monetary policy in the face of relative price shocks in an inflation targeting regime with anchored expectations. The committee's conclusion is that by now it should already be clear that there is no mechanical relationship between shocks that produce relative price adjustments and monetary policy. Therefore, the committee agreed to exclude this message from its next meeting onward, understanding that this should not be read as a change in its approach to monetary policy.

Regarding the convenience of signaling the next steps of monetary policy, paragraph 22 shows that, despite the reduction of the degree of asymmetry in the risk balance, all committee members agree that the current conjuncture makes it appropriate to maintain greater flexibility in monetary policy. This means refraining from giving any indication about next steps. In this context, committee members stressed the importance of emphasizing their commitment to conduct monetary policy with the goal of keeping the inflation path consistent with the targets.

Policy decision

According to the committee, the decision to keep the policy rate stable is consistent with the convergence of inflation towards the target within the relevant policy horizon, which includes 2019 and, to a lesser extent, 2020. The economic scenario still calls for stimulative monetary policy. However, the Copom maintains the warning 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 minutes provide a balanced assessment of the economic juncture, highlighting, on the one hand, the challenging external scenario and, on the other, the reduction of domestic uncertainty. The forecasts, that had been presented in the meeting statement, in the baseline scenario, with a constant Selic rate at 6.5% pa, are in line with the targeted path until 2020, suggesting rates may be on course to hibernate at the current level for quite some time – barring unforeseen shocks. Given this backdrop, the Copom will probably leave its base rate unchanged at 6.5% pa in its December 12 policy meeting.



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