Itaú BBA - What we expect from the 4Q2016 Inflation Report

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What we expect from the 4Q2016 Inflation Report

December 19, 2016

The IR will probably reinforce the monetary authority’s recent statement which, as we see it, signals a 50 bps interest rate cut at its January meeting.

This Thursday, the Copom releases its fourth quarter Inflation Report (IR). The IR will probably reinforce the monetary authority’s recent statement which, as we see it, signals a 50 bps interest rate cut at its January meeting.  We expect to see few changes to the Copom’s inflation forecasts since the minutes from November.  In 2016, we expect to see inflation forecasts at or around 6.5% in both the baseline and the market scenarios.  In the baseline scenario, we expect inflation forecasts to be at 4.4% for 2017 and 3.7% for 2018.  In the market scenario, we expect inflation forecasts at 4.7% for 2017 and 4.6% for 2018.  In our assessment, the Central Bank’s stance, conditional on the forward looking inflation scenario, which signals below-target forecasts for 2018, corroborate our call of more intense interest rate cuts from January onwards.

This Thursday, the Copom releases its fourth quarter Inflation Report for 2016.  The following table summarizes our attempt to replicate the Central Bank (BCB) model, based on the baseline scenario (constant exchange rate and Selic benchmark rate) and market scenario (exchange rate and Selic according to the Focus survey).  December 9 was the cut-off date, when the exchange rate stood at around 3.40 BRL to the dollar.

In 2016, we expect inflation forecasts to fall to 6.5% in both scenarios, down from 6.6% in the November minutes, following downside surprises from inflation in recent months.

In the baseline scenario, we expect to see the inflation forecast for 2017 at 4.4%, the same result reported in the minutes of the most recent Copom meeting and the third quarter IR.  In light of lower interest rates, we estimate a slight increase for 2018 to 3.7% from 3.6% reported at the November meeting.

In the market scenario, the Focus exchange rate forecasts stand at 3.45 for 2017 and 3.50 to the dollar in 2018.  The Focus outlook for the Selic rate is 10.5% in 2017 and 10.00% in 2018.   In this scenario, we expect forecasts of 4.7% for 2017 and 4.6% for 2018, mirroring the figures disclosed at the November meeting.

In its statement, we expect the committee to repeat the message from the November minutes. Back then, the BCB did not commit to a 50 bps cut at the January meeting, but made it clear this was its baseline scenario.  Indeed, certain elements in its statement suggest the BCB would have already chosen to speed up the rate of interest rate cuts in November if the US elections had not sprung a surprise.

In our view, the BCB’s stance conditional on the forward looking inflation scenario, with  below-target forecasts for 2018, corroborate our call of more intense interest rate cuts beginning in January.  We believe the domestic scenario continues to support monetary policy easing and that developments in the external environment will not affect that.

We reckon that the BCB’s statement and our expectations for the economy over the next few months are consistent with our forecast for a faster cycle of interest rate cuts, starting at the January meeting.  We are forecasting a sequence of 50 bps cuts throughout 2017 and a final 25 bps adjustment, with the Selic ending the year at 10.00% p.a.


 


 



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