Itaú BBA - Copom Minutes: Waiting for clarity

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Copom Minutes: Waiting for clarity

March 26, 2019

For the time being, given all the uncertainty surrounding the central scenario, we expect the Selic to remain unchanged in coming meetings.

The Copom meeting minutes point to a committee that is aware of the weaker-than-expected pace of the economic recovery, and that attributes this weakness to the aftereffects of the shocks seen in 2018 (in particular the truck drivers stoppage and the tightening of financial conditions). The text notes, too, that as of yet the GDP forecasts for 1Q19 or 2Q19 onward have not changed, which hints that, if/when these do, the Copom will reassess whether its stance is appropriately expansionary. Given the current weakness seen in activity data, this might indicate willingness to adjust the degree of stimulus in the not too distant future, perhaps even within the first half of 2019. But the minutes also bring plenty of mentions on the needed fiscal reforms and the risks failure of this agenda would pose for the scenario. In sum, regardless of the state of the economy, the authorities seem to be unlikely to budge until we have much more clarity on the outlook for social security reform. Thus, for the time being, given all the uncertainty surrounding the central scenario, we expect the Selic to remain unchanged in coming meetings.

Recent economic developments and the baseline scenario

In the statement, the committee assessed that recent economic activity data show a slower-than-expected growth pace, albeit with a gradual recovery. The external scenario remains challenging – on the one hand, risks associated with the normalization of interest rates in advanced economies have receded, while, on the other hand, risks associated with a global slowdown increased.

The committee continues to see underlying inflation measures at appropriate or comfortable levels, including those components most sensitive to the economic cycle and monetary policy.

The text then outlines the Copom's main assumptions and forecasts. Considering the expectations for exchange and interest rates reported in the Focus survey, Copom’s forecasts remained around 3.9% and 3.8% for 2019 and 2020, respectively. This scenario assumes interest rates that end 2019 at 6.50% and reach 7.75% in 2020, in addition to an exchange rate at 3.70 BRL in YE2019 and 3.75 BRL in YE2020. The regulated price inflation forecasts in this scenario remained at 5.1% for 2019 and 4.7% for 2020. In the reference scenario, with constant interest rates at 6.50% pa and a constant BRL at 3.85, inflation forecasts increased to 4.1% for 2019 (from 3.9%) and remained at 4.0% for 2020. In this scenario, forecasts for regulated prices inflation are 5.4% for 2019 (from 5.1%) and 4.8% for 2020 (from 4.5%).

Risks

Repeating the change made in the post-meeting statement, the committee described the balance of risks around inflation as symmetrical, therefore removing the emphasis that was being placed on inflationary risks. They highlight that all members agree with this evaluation, despite getting to this conclusion based on different assessments about the recent evolution of risks around the baseline scenario. Hence, it is possible that some in the board see a symmetric balance due to higher risks regarding the weak recovery pace – that is, they may understand that the current sluggishness is caused by more than just the past shocks – while others might get to the same conclusion because they see lower risks around the agenda of economic reforms.

Policy discussion

In paragraph 12, the Copom discussed evidences of an activity slowdown in the fourth quarter of 2018, with a slower-than-expected pace. The committee also assessed the growth forecasts for 2019, including those reported in the Focus survey, and concluded that the recent downward revisions largely reflect the lower "statistical carryover” effect that comes from the 4Q18 GDP release. However, some of the revisions also seem to reflect, according to the Copom, preliminary indicators for the first months of the current quarter. That being said, the committee understands that there was no significant change in the GDP growth forecasts at the margin – that is, for the first or second quarter onward – which is consistent with the Copom’s baseline scenario of a gradual recovery of the Brazilian economy .

Still on economic activity, paragraph 13 highlights the several shocks that hit the Brazilian economy throughout 2018, including the truckers’ stoppage, the worsening of the external scenario for emerging economies and the high uncertainty regarding the direction of economic policy, which tightened financial conditions and had persistent effects on economic activity. The Copom assesses that these shocks likely contributed to a significant reduction of economic growth, and also stresses that acceleration to more robust levels will depend on the approval and implementation of the necessary reforms, especially in the fiscal side.

Paragraph 14 shows that the Copom continues to see a challenging international context. In particular, the committee assessed two distinct scenarios for the US economy: the first involves significant risks of an economic downturn, while the second assumes continuity of the vigor seen in recent years. These two scenarios have opposite implications for the Fed's monetary policy, which has signaled the intention to wait for this uncertainty to dissipate over time. In addition, the Copom assesses that the risks of a global economic deceleration have intensified, with symptoms of a significant economic slowdown in Europe.

In paragraph 15, the Copom discusses recent inflation forecasts and underlying measures. The committee stresses that it anticipates rising inflation in the coming months: twelve-month inflation is expected to peak around April or May due to a low basis of comparison, but will likely retreat ahead and close the year around their forecasts. The Copom also emphasizes that the consolidation of this favorable scenario depends on the necessary reforms and adjustments in the Brazilian economy, which are paramount for maintaining anchored inflation expectations.

On the risks surrounding the inflation scenario, paragraph 16 highlights that all committee members agree the balance of risks is symmetrical, although with distinct assessments regarding the evolution of each separate risk. The text kept the emphasis in paragraph 17 on the need to conduct monetary policy, in the face of uncertainty, with caution, serenity and perseverance.

In paragraph 22, the Copom reaffirms that it considers important to observe the behavior of the Brazilian economy over time, under a lower degree of uncertainty and free from the various shocks to which it was submitted last year. Importantly, the committee again stresses that this evaluation will likely take time and should not be completed in the short term.

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 growing extent, 2020. The Copom affirmed once more that the economic scenario calls for stimulative monetary policy (lower-than-neutral rates), but also repeated the warning that the continuity of reforms and adjustments in the Brazilian economy is essential for sustainably-low inflation in the medium and long term.

Sticking to its recent practice, the committee kept its flexibility to set their next steps according to the evolution of economic activity, the balance of risks, forecasts and expectations for inflation. As in the post-meeting communiqué, the Copom emphasized that it will be important to observe the behavior of the Brazilian economy over time, in order to assess its evolution in the absence of the shocks that happened in 2018 and given the lower levels of uncertainty. The committee considers that this evaluation will take time, and is unlikely to be completed in the short term.

Interpretation

Therefore, the meeting minutes point to a committee that is aware of the weaker-than-expected pace of the economic recovery, and that attributes this weakness to the aftereffects of the shocks seen in 2018 (in particular the truck drivers stoppage and the tightening of financial conditions). The text notes, too, that as of yet the GDP forecasts for 1Q19 or 2Q19 onward have not changed, which hints that, if/when these do, the Copom will reassess whether its stance is appropriately expansionary. Given the current weakness seen in activity data, this might indicate willingness to adjust the degree of stimulus in the not too distant future, perhaps even within the first half of 2019. But the minutes also bring plenty of mentions on the needed fiscal reforms and the risks failure of this agenda would pose for the scenario. In sum, regardless of the state of the economy, the authorities seem to be unlikely to budge until we have much more clarity on the outlook for social security reform. Thus, for the time being, given all the uncertainty surrounding the central scenario, we expect the Selic to remain unchanged in coming meetings.



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