Itaú BBA - What we expect for the Inflation Report

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What we expect for the Inflation Report

September 26, 2016

The IR is likely to show forecasts below the target for 2018, consistent with our scenario for an interest rate cut in October.

On Tuesday, the Copom will publish its Q3 Inflation Report (IR). The IR is likely to reinforce the monetary authority’s recent communication, which in our view signals that a monetary easing cycle is approaching, even if the precise timing is still data dependent. We estimate the Copom forecasts for the IPCA in 2017 at 4.5% in the reference scenario (4.7% in the previous IR, 4.5% in the last monetary policy minutes); and 5.1% in the market scenario (5.5% in the previous IR and 5.1% in the last minutes). For Q3 2018, we expect the BCB’s forecasts at 3.9% in the reference scenario and 4.8% in the market scenario. We consider a small scale econometric model similar to the one traditionally used by the Central Bank in our analysis, although we admit that the new Copom team may come to introduce improvements in the analytical framework. We believe that the BCB’s projected inflation below the target for 2018, with the Selic rate remaining constant over the projected horizon, and given the conditional Copom communication, is consistent (although not conclusive) with our expectation that a cautious easing cycle of interest rates will begin in the October meeting.

On the 27th, the Copom will publish its Q3 Inflation Report (IR). We believe that the main focus of the report will be the evolution of forecasts for 2018, since the Copom's communication should not differ much from the last minutes.

The table below summarizes our attempt to replicate the central bank model, according to the reference scenario (constant Selic rate and exchange rates) and the market one (Selic and exchange according to the Focus survey). We use September 16th as the cutoff date, when the exchange rate was at 3.25 reais per dollar.

In the reference scenario, we expect the inflation forecast for 2017 at 4.5%, the same result recorded in the last meeting’s monetary policy minutes and similar to the previous IR (4.7%). For the first half of 2018, we estimate lower forecasts against the last IR, given the exchange rate appreciation and falling inflation expectations. For Q32018, first presented in this IR, we expect the BCB’s forecast at 3.9%, significantly below the target of 4.5% for the year.

For the market scenario, the Focus survey forecasts for the exchange rate are at 3.45 reais per dollar in 2017 and 3.60 reais per dollar for Q32018. For the Selic rate, the Focus survey’s expectations are at 11% for 2017 and 10.5% for Q32018. In this scenario, we estimate the BCB’s forecast at 5.1% for 2017 and 4.8% for Q32018.

Regarding its communication, we expect the Copom to repeat the same message from August’s meeting minutes, stressing that the easing of monetary policy will depend on the evolution of several factors: that the persistence of food price shocks is limited, that the IPCA components more sensitive to monetary policy and economic activity (i.e. services) present disinflation in adequate speed, and diminishing uncertainty regarding the execution and composition of the fiscal adjustment. In line with Central Bank governor’s recent speech, we believe that the IR will indicate that the relevant horizon for monetary policy actions is not static and shifts along time - consistent with a gradual migration of the focal point from 2017 to 2018.

In our view, the conditional approach to the scenario and 2018  inflation forecasts below the target (actually undershooting the same more markedly as the forecast horizon is extended) in the reference scenario reinforce our call for the beginning of monetary easing in October, even though there is no clear commitment to this scenario. We believe that the data and news flow in the coming weeks, including with regards to the fiscal reform agenda, will strengthen the case for easing in October.

Thus, we maintain our scenario that the Copom will start an easing cycle with a 0.25 p.p. cut in the Selic rate in the next Copom meeting in October, accelerating the pace to 0.50 p.p. in the November meeting.


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