Itaú BBA - COPOM Minutes: no imminent action, in a more uncertain environment

Macro Brazil

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COPOM Minutes: no imminent action, in a more uncertain environment

junio 26, 2018

The minutes reinforce the message that forward guidance has been abandoned, for the time being, given the currently uncertain environment.

The Copom minutes reinforce the message that forward guidance has been abandoned, for the time being, given the current highly uncertain environment. The text also informs that the Copom will closely monitor price dynamics and inflation expectations, searching for signs that recent shocks might be spreading through the economy, in which case presumably a policy response might be in order. The committee also notes, repeatedly and rightly, that we are in for a batch of pretty choppy inflation and activity data releases, under the influence of the transportation sector disruption, which should make the signal to noise ratio abnormally low. This suggests that the authorities will likely be unable to make definitive inferences about where the economy and inflation risks stand at the next policy meeting, on July 31-August 1, which reinforces that its approach will be led by the secondary effects on the abovementioned shocks on prospective inflation. With well-anchored inflation expectations and a wide output gap, we expect the current inflation uptick to be transitory, and hence the base rate to remain unchanged until year end. But the risk is to the upside. We’ll learn more about the policymakers’ views with the release of the 2Q18 Inflation Report and accompanying press conference by president Goldfajn on Thursday. 
 

Recent economic developments and the baseline scenario

According to the Copom, data for the month of April suggest a more consistent activity than in previous months, but the trucker’s stoppage in May makes it difficult to read the most recent evolution of economic activity data and should have an impact on indicators related to May and June. The baseline scenario contemplates continuity of the process of economic recovery, in a more gradual pace. The external scenario continues to be described as more challenging and more volatile, with lower risk appetite in relation to emerging economies.

The Copom expects that, in the short-term, inflation will reflect the upward effects (in the committee’s wording, significant and temporary) of the trucker’s stoppage and relative price adjustments. However, underlying inflation measures remain at low levels, including the components most sensitive to monetary policy (that is, service prices).

The text then outlines the Copom’s key assumptions and forecasts. Considering interest rate and exchange rate expectations reported in the Focus survey, the committee’s estimates for inflation hover around 4.2% for 2018 and 3.7% for 2019 (vs. 3.6% and 3.9% in the previous meeting). In this scenario, the exchange rate would reach 3.63 reais per U.S. dollar by YE18 and 3.60 reais by YE19, with regulated prices inflation at 7.2% and 4.6%, respectively (vs. 5.2% and 4.2% previously).

The committee also presented a scenario in which the exchange rate is constant at 3.70 and the benchmark interest rate at 6.50%, in which its inflation forecast is also 4.2% for 2018, but shifts to 4.1% for 2019 (with regulated prices rising 7.4% and 4.8%, respectively).

Risks

The Copom continues to envisage downward and upward risks to the basic inflation scenario. The main downward risk is still the possibility that low levels of past inflation may continue through inertial mechanisms. To the upside, the risks come from the possible frustration of expectations about the needed fiscal adjustments and reforms that may affect risk premia and inflation within the relevant policy horizon. This risk increases if the reversal of the global scenario for emerging economies — no longer described as favorable — continues. In fact, the Copom stated that the perpectives of such reversion have intensified since its last meeting, with potential impacts on inflation’s path toward its targets.

Policy discussion

Paragraph 11 shows that the committee characterized April’s economic activity data as more consistent than in previous months. However, the truckers’ stoppage is described as an event that makes it difficult to interpret the recent evolution of economic activity. According to the COPOM, data for May and, possibly, June will likely show distortions stemming from the stoppage, and greater clarity as to the pace of recovery should resurface only with the readings for July and August. The committee’s baseline scenario contemplates recovery at a more gradual pace than before the stoppage.

On the international environment, the committee assesses in paragraph 12 that the scenario remains challenging. The Copom’s baseline scenario is that of a gradual monetary policy normalization in central economies, with risks of a greater impact on emerging economies, which may reinforce the relative price adjustments (read exchange rates) and financial conditions volatility. Also mentioned was the intensification of trade-related risks, with possible impacts on global growth. In this context, the committee once again highlighted the ability of the Brazilian economy to absorb the external headwinds, due to its sound balance of payments, low inflation in the recent past with anchored expectations and the prospect of economic recovery.

In paragraphs 13 and 14, the committee discusses the scenario for inflation. There is consensus among Copom members that short term inflation will reflect the upward effects of the truckers’ stoppage, but the baseline scenario is that such effects are temporary. The committee stresses that underlying inflation measures were at low levels in the recent past and that relative price movements, in a context of anchored inflation expectations, could accelerate the convergence of inflation to targets, without risk of reverting the favorable dynamics after this adjustment is completed.

Paragraphs 15 and 16 discuss the potential effect of the exchange rate on monetary policy. With anchored expectations, only secondary effects should be addressed by the Copom. Furthermore, the committee stresses that the possible reaction to the change in relative prices would be symmetrical (following the same approach for inflationary and deflationary shocks), but emphasized that this framework requires well-anchored inflation expectations. The committee discussed again the degree of exchange rate pass-through to the Brazilian economy and, given its many drivers (for instance, economic slack and how anchored expectations are) restated that it will monitor different measures of is impact on inflation and underlying inflation. 

Regarding the evolution of the baseline scenario, the committee pointed out in paragraph 20 that the truckers’ stoppage will have temporary and significant effects on inflation and economic activity, which will contaminate the next readings. Paragraph 21 emphasizes that the Copom agreed that, in the short term, this would make it harder to verify whether the economic evolution is in line with its basic scenario – and concluded that this reinforces the importance of monitoring the secondary effects of these shocks on inflation. On the balance of risks for the prospective inflation path, paragraph 22 shows that the committee evaluates that the downside risk stemming from the reduced levels of past  inflation has diminished, but the committee reinforced the importance of the continuity of adjustments and reforms in the Brazilian economy, in order to mitigate risks resulting from the deterioration of the external scenario.

Paragraph 23 emphasizes that all members agreed that the currently high level of uncertainty makes it adequate to abandon the forward guidance about the next monetary policy steps. This is the reason behind the absence of explicit signaling regarding the next meeting in the post-meeting statement.

In paragraph 24, the committee reiterated that monetary policy will only focus on the evolution of inflation forecasts and expectations, the balance of risks and economic activity. In particular, relative price shocks will only be dealt with in terms of the secondary impact they may have on prospective inflation. In that regard, the committee reiterated the importance of insisting on the communication that there is no mechanical relationship between recent shocks and monetary policy.

Policy decision

On paragraph 32, the committee indicated that the evolution of the baseline scenario and the balance of risks makes it adequate to maintain the benchmark rate at the current level, stressing again that the next monetary policy steps will continue to depend on the evolution of economic activity, the balance of risks and inflation forecasts and expectations.

Interpretation

In the minutes released today, the Copom reinforces the message that forward guidance has been abandoned, for the time being, given the current highly uncertain environment. The text also informs that the comittee will closely monitor price dynamics and inflation expectations, searching for signs that recent shocks might be spreading through the economy, in which case presumably a policy response might be in order. The committee also notes, repeatedly and rightly, that we are in for a batch of pretty choppy inflation and activity data releases, under the influence of the transportation sector disruption, which should make the signal to noise ratio abnormally low. This suggests that the authorities will likely be unable to make definitive inferences about where the economy and inflation risks stand at the next policy meeting, on July 31-August 1, which reinforces that its approach will be led by the secondary effects on the abovementioned shocks on prospective inflation. With well-anchored inflation expectations and a wide output gap, we expect the current inflation uptick to be transitory, and hence the base rate to remain unchanged until year end. But the risk is to the upside. We’ll learn more about the policymakers’ views with the release of the 2Q18 Inflation Report and accompanying press conference by president Goldfajn on Thursday.



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