Itaú BBA - COPOM Minutes: Selic rate still at comfortable level

Macro Brazil

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COPOM Minutes: Selic rate still at comfortable level

mayo 14, 2019

The minutes suggest the Copom is still comfortable with the level of the Selic rate, but we expect the BCB to cut rates again in September.

• The minutes suggest that, despite the disappointing recovery pace, the Copom is still quite comfortable with the current level of the Selic. The committee indicates that, while 1Q19's GDP may well have a negative print, activity is likely to rebound hereafter, and adds that it will need to see signs that the aftereffects of the 2018 shocks have passed before any reassessment. Moreover, the text hints that the Copom will also need to gauge to what extent uncertainty about fiscal sustainability may be hindering activity. The authorities appear to believe, in summary, that approval of the pension reform may be a sufficient condition to strongly accelerate growth – we think it is a necessary one, but not sufficient. We still expect the BCB to resume rate cuts in its September meeting. The second half of June, with a Copom meeting, publication of the QIR, and definition of the inflation target for 2022, will see the next steps of Brazil's monetary policy. 

Recent economic developments and the baseline scenario

Following the change implemented in the post-meeting communiqué, the Copom revised its assessment of the current economic scenario, stating that recent activity indicators suggest that the slowdown seen at the end of 2018 extended into early 2019. The authorities point out that the first quarter of the year is likely to show negative growth, and also that the change in market forecasts embeds a reduction of expected growth pace for the coming quarters. However, the committee states that, despite the interruption of gradual economic recovery, their baseline scenario contemplates a rebound ahead.

Regarding the external environment, the Copom believes that the scenario remains challenging. According to the committee, risks associated with the normalization of interest rates in advanced economies scaled down in the short and medium term, while risks associated with a global deceleration remain as a source of pressure.

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

The text then describes Copom's main assumptions and forecasts. Considering the expectations reported in the Focus survey for exchange and interest rates, Copom's inflation forecasts for 2019 rose to 4.1% (from 3.9%), and remained at 3.8% for 2020. This scenario assumes the interest rate to end 2019 at 6.50% and reach 7.50% in 2020, in addition to an exchange rate ending 2019 at BRL/USD 3.75 and 2020 at BRL/USD 3.80. Forecasts for regulated price inflation rose to 5.3% in 2019 and to 5.0% in 2020 (versus 5.1% and 4.7%, respectively). In the reference scenario, with constant interest rate at 6.50% and exchange rate at BRL/USD 3.95, the inflation forecasts for 2019 increased to 4.3% (from 4.1%) and remained at 4.0% for 2020. In this scenario, forecasts for regulated price inflation rose to 5.6% for 2019 (from 5.4%) and 5.1% for 2020 (from 4.8%). 

Risks 

The committee continues to describe the balance of risks as symmetrical. However, it now assesses that the risk associated with economic slack rose at the margin. The description of the upside risks – namely, the possibility of frustration of expectations about the continuity of the necessary reforms and adjustments in the Brazilian economy, and the risk of a deterioration of the scenario for emerging economies – did not change. 

Policy discussion

In paragraph 12, the Copom assessed the recent evolution of economic activity and concluded that the deceleration seen at the end of 2018 extended into 2019. In particular, the committee understands that indicators suggest a significant probability of GDP contraction in 1Q19. According to the Copom, the weaker-than-expected first quarter data led to substantive revisions to 2019 growth forecasts compiled by the Focus survey, with implications for the remainder of the year due to the statistical carry-over effect. In addition to the worse starting point, the committee acknowledges that such revisions embed also some reduction in the growth pace that is expected for the coming quarters. Despite its assessment that the process of economic recovery has been interrupted, the Copom points out that its baseline scenario features a rebound ahead.

Still on economic activity, in paragraph 13 the committee members stated once more that the Brazilian economy suffered several shocks in 2018, which produced impacts on the economy and relevant tightening of financial conditions, and have likely reduced growth significantly. The Copom notes that some of these effects still persist.

In paragraph 14, the committee discussed the interpretation of its communication regarding the need to watch the evolution of the Brazilian economy in order to reach a clear diagnosis about its recent performance. The Copom highlights that, in addition to the aforementioned shocks, uncertainties regarding economic fundamentals – notably fiscal sustainability – have adverse effects on economic activity. In this sense, paragraph 15 highlights that the committee sees expansionary potential in reforms that generate sustainability of the future fiscal trajectory. 

Regarding the international context, paragraph 17 shows that the committee considers a still-challenging scenario. Given recent information on developed economies and the communication of important central banks, Copom's baseline scenario considers that short and medium term risks associated with the normalization of interest rates in the central economies have diminished. But the committee believes that the risks associated with a slowing global economy remain, and that uncertainties about geopolitical and economic policies can contribute to even lower global growth.

In paragraph 18, the Copom discusses recent inflation forecasts and underlying inflation measures. The latter are at appropriate levels and indicate convergence of inflation towards the 2019 and 2020 targets, according to the committee. The authorities expect that 12-month inflation will peak in the short term and then retreat and end 2019 around the inflation target. Again, the committee emphasized that the consolidation of this favorable scenario, with inflation at the targets in the medium and long term, depends on the progress of the necessary reforms and adjustments in the Brazilian economy.

According to the Copom, the balance of risks is still symmetrical, as paragraph 19 highlights, despite the assessment that the risk associated with economic slack increased at the margin.

Paragraph 20 reports that the committee decided not to repeat in further communication the message that the best way to keep the inflation path towards the targets is to conduct monetary policy with caution, serenity and perseverance. The Copom understands that this should not be interpreted as a change in its monetary policy strategy.

In paragraph 25, the Copom reaffirms that it considers important to observe the behavior of the Brazilian economy over time, with a lower degree of uncertainty and free from the remaining effects of the various shocks to which it was submitted last year, and especially with reduction of the degree of uncertainty to which the Brazilian economy continues to be exposed. The committee stresses once again that it believes that this evaluation is time-consuming and should not be completed in the short term.

Policy decision

According to the committee, the decision to keep the policy rate stable is consistent with the convergence of inflation towards the target within the relevant policy horizon, which includes 2019 and, to a greater extent, 2020. The Copom affirmed once more that the economic scenario calls for stimulative monetary policy (lower-than-neutral rates), but also repeated the warning that the continuity of reforms and adjustments in the Brazilian economy is essential for sustainably-low inflation in the medium and long term. 

Sticking to its recent practice, the committee kept its flexibility to set their next steps, according to the evolution of economic activity, the balance of risks, forecasts and expectations for inflation. As in the post-meeting communiqué, the Copom emphasized that it will be important to observe the behavior of the Brazilian economy over time, in order to assess its evolution in the absence of the shocks that happened in 2018 and – now with greater emphasis – with lower levels of uncertainty. The committee considers that this evaluation will take time, and is unlikely to be completed in the short term. 

Interpretation

Therefore, the Copom minutes suggest that, despite the disappointing recovery pace, the Copom is still quite comfortable with the current level of the Selic. The committee indicates that, while 1Q19's GDP may well have a negative print, activity is likely to rebound hereafter, and adds that it will need to see signs that the aftereffects of the 2018 shocks have passed before any reassessment. Moreover, the text hints that the Copom will also need to gauge to what extent uncertainty about fiscal sustainability may be hindering activity. The authorities appear to believe, in summary, that approval of the pension reform may be a sufficient condition to strongly accelerate growth – we think it is a necessary one, but not sufficient. We still expect the BCB to resume rate cuts in its September meeting. The second half of June, with a Copom meeting, publication of the QIR, and definition of the inflation target for 2022, will see the next steps of Brazil's monetary policy. 



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