Itaú BBA - Copom: ready to resume easing, conditional on reform

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Copom: ready to resume easing, conditional on reform

June 19, 2019

The statement opens the way for a resumption of monetary easing, provided there is “concrete progress” in the reform agenda.

The Copom decision to leave the base rate unchanged at 6.5% pa was widely anticipated. Its statement opens the way for a resumption of monetary easing, as early as the July 31st policy meeting, provided there is “concrete progress” in the reform agenda. The committee concedes that the economic recovery has stalled and provides forecasts, in the baseline scenario (constant exchange at BRL 3.85 and policy rates at 6.5% pa), that are inconsistent with the target path – 3.7% vs. a 4.0% target for 2020. But it rightly cautions that the benign inflation scenario hinges on the reforms. We will learn more about the authorities’ views with the release of the meeting minutes at 08:00 AM on Tuesday, June 25. The central bank’s views will be further outlined with the Quarterly Inflation Report and the following press conference on June 27 (the same day when we’ll learn the inflation target for 2022, which we expect to be set at 3.5%). We remain constructive with the outlook for reforms, and as a result, still expect the Copom to resume easing at the July policy meeting, with a 25-bp move, and the base rate to end the year at 5% pa.

Details

In the statement, the committee affirmed that recent economic activity data indicate that the process of economic recovery has been interrupted (in the May meeting, the recovery process was described as losing momentum; in the March meeting it was described as gradual). Faced with this new deterioration, the Copom states that its scenario contemplates the resumption of the process of recovery ahead, in a gradual pace.

The external scenario now is described as less adverse, given changes in the outlook monetary policy in the main economies. However, the risks associated with a global slowdown remain.

The committee assesses that underlying inflation measures are at appropriate levels, including the components most sensitive to the economic cycle and monetary policy.

The Focus survey inflation expectations declined to 3.8% from 4.0% in 2019 and remained at 4.0% and 3.75% for 2020 and 2021, respectively.

With regard to Copom's own forecasts, in the scenario with constant interest at 6.50% pa and a constant exchange rate of BRL 3.85 (rounded average of the five business days to the Friday before the meeting), forecasts declined to 3.6% (from 4.3%) for 2019 and 3.7% for 2020 (from 4.0%). In the scenario with trajectories for interest and exchange rates extracted from the Focus survey, Copom forecasts receded to 3.6% in 2019 (from 4.1%) and increased slightly to 3.9% for 2020 (from 3.8%). This scenario assumes an interest rate trajectory ending 2019 at 5.75% pa and reaching 6.50% in 2020, in addition to an exchange rate ending both 2019 and 2020 at BRL 3.80.

The balance of risks for inflation continued to be described as symmetrical, despite having evolved favorably. Among the risk factors that are normally being discussed (high economic slack, failure to deliver reforms and deterioration of the external scenario), the committee chose to highlight the one related to an eventual frustration of expectations about the continuity of reforms, by affirming that, at this juncture, it is the most important factor.

The committee maintained its statement that it is important to observe the behavior of the Brazilian economy over time, after the reduction of the uncertainty to which the economy is still exposed, but no longer mentioned the remaining effects of the shocks observed in 2018.

As in recent communiqués, the Copom repeated that the continuity of reforms is essential for the decline in structural interest rate and for the sustainable recovery of the economy. According to the committee, the perception of the continuity of this agenda affects expectations and current macroeconomic forecasts. Importantly, the Copom indicated that in order to consolidate the benign prospective scenario for inflation, it is essential to have concrete progress in the reform agenda.

The Copom decision to leave the base rate unchanged at 6.5% pa was widely anticipated. Its statement opens the way for a resumption of monetary easing, as early as the July 31st policy meeting, provided there is “concrete progress” in the reform agenda. The committee concedes that the economic recovery has stalled and provides forecasts, in the baseline scenario (constant exchange at BRL 3.85 and policy rates at 6.5% pa), that are inconsistent with the target path – 3.7% vs. a 4.0% target for 2020. But it rightly cautions that the benign inflation scenario hinges on the reforms. We will learn more about the authorities’ views with the release of the meeting minutes at 08:00 AM on Tuesday, June 25. The central bank’s views will be further outlined with the Quarterly Inflation Report and the following press conference on June 27 (the same day when we’ll learn the inflation target for 2022, which we expect to be set at 3.5%). We remain constructive with the outlook for reforms, and as a result, still expect the Copom to resume easing at the July policy meeting, with a 25-bp move, and the base rate to end the year at 5% pa.



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