Itaú BBA - Inflation report: low for long

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Inflation report: low for long

September 21, 2017

Given the forecasts and the Copom guidance we stick to the view that the Copom will cut the Selic by 75bps in October.

The BCB's Inflation Report (IR) for 3Q17 updates forecasts, as usual, showing inflation at 4.3% at the end of 2018 and at 4.2% by 4Q2019 in the active scenario, with interest rate and exchange rate forecasts in line with market expectations (according to the Focus report). In the hybrid scenario, with a constant exchange rate and the interest rate following market expectations, forecasts are at 4.1% for end-2018 and 3.9% for 4Q2019. These forecasts seem to embed above consensus views on administered prices, hence may move down over time. Be that as it may, they are consistent with a gradual end of the easing cycle, in the 7.0% neighborhood by year-end. They are, in fact, consistent with the Selic steady at said level until the end of 2018. The text confirms the signaling of deceleration, presented in the latest policy meeting statement and minutes, indicating that the next Copom decision is as yet firmly pointed a 75bps move. 

Given the forecasts and the Copom guidance we stick to the view that the Copom will cut the Selic by 75bps in October. We note that the decision will be data dependent, so the authorities’ assessment of the forward looking scenario, but the bar to deviate from that decision (in any direction) in the next meeting seems high.

In its projections, the committee presented forecasts up to 4Q20. Inflation estimates for 2018, the dominant policy horizon, are below or (slightly below) the target in all four scenarios. Specifically, the market scenario (market expectations for exchange rate and interest rate) shows inflation at 4.3%, slightly below the center of the target (4.5%). 

Forecasts for 2019, which will increasingly gain importance in Copom discussions, range between 3.7% and 4.2% - the latter, which considers market exchange rate and interest rate, is exactly on the 2019 inflation target. For 2020, forecasts that encompass market estimates for interest rate, hovers around the 4.0% inflation target. The projections for 2019 and 2020 around the target, under the assumption of market interest rates, signals that interest rates may remain at low levels for a long time. 

In our view, the current projections are consistent with a 75bps move in October followed by a 50 bps in December, that would take the Selic to 7.0% pa in the end of the year and conclude the easing cycle. However, we note that further benign inflation suprises may lead the Copom to opt for extending the cycle. In this case, we favor the maintenance of a gradual approach. The stage of the cycle and clear signs of economic recovery reduce the sense of urgency for the Copom, which decreases the benefits of faster cuts.

As usual, the IR includes interesting studies. There is a box that shows the survey that the BCB made with market participants for the Brazilian neutral real interest rate in April. The survey shows the median at 4% over a five year period. The Copom highlighted that the ex-ante real interest rate is around 3%, below the estimates for the neutral real interest rate. In another box, the Copom shows that service and industrial inflation have a higher persistence than food and monitored good inflation. The study highlights that the Copom’s and market’s forecasts for 2018 consider a normalization in food prices. However, on the short term, there are downside risks for inflation due to secondary effects of the positive food shock on more persistent items. Another box updates the central bank GDP forecasts. The BCB increased its growth forecast from 0.5% to 0.7% for 2017. For 2018, the central bank expects a 2.2% GDP growth.

In summary, the IR released today shows that the signaling of moderately slower easing in October remains. The forecasts presented by the Copom suggest the Selic rate will reach 7.0% in December and remain at this level for a long period. For now, we maintain our call of Selic at 7.0% at the year-end and staying there in 2018, with a 75bps cut in October meeting, followed by a final 50 bps cut in December. Favorable inflation dynamics suggests the risk to our call is tilted to the downside. We will, as always, monitor events closely, in this particularly fluid and uncertain environment.



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