Itaú BBA - Copom: When facts change

Macro Brazil

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Copom: When facts change

mayo 16, 2018

The Copom decided to end the easing cycle leaving the base rate unchanged at 6.5%

The Copom decided to end the easing cycle leaving the base rate unchanged at 6.5% pa (we had expected a minor, final 25-bp cut). The authorities based their decision, according to the statement, on the change in the balance of risks determined by a changed external scenario. We’ll learn more about the authorities’ thinking with the release of the Copom minutes on Tuesday, May 22, at 08:00, São Paulo time. Still, it appears that this is the bottom for the Selic and that the next movement, whenever it happens, will be up.
 

Details

In the statement, the Committee assessed that the latest economic activity data has shown some deceleration, but still point to a consistent, albeit gradual, recovery. The external scenario is no longer described as favorable by the Copom, but instead, as more challenging and more volatile. In particular, external risks, largely related to the normalization of interest rates in advanced economies, led, according to the committee, to adjustments in international financial markets and a reduction in risk appetite for emerging economies.

The Copom evaluates that the evolution of inflation remains favorable, with several measures of underlying inflation still at low levels, including the components more sensitive to the monetary policy (that is, prices of services). 

Inflation expectations, according to the central bank Focus survey, fell to 3.5% for 2018 (from 3.6% in the inflation report) and 4.0% for 2019 (from 4.2%), while remaining at 4.0% for 2020. Regarding Copom's projections, inflation in the market scenario declined significantly to 3.6% in 2018 (from 3.8%) and to 3.9% in 2019 (4.1%), assuming that the interest rate ends 2018 at 6.25% and 2019 at 8% and with the exchange rate at R$/US$ 3.40 at the end of 2018 and 2019. With a constant interest rate of 6.50% and exchange rate at R$/US$ 3.60 (average of the five business days to the Friday before the meeting), projections are around 4.0% for both 2018 and 2019.

The Copom stressed that in its central scenario there are still risk factors to the upside and to the downside. The main downside risk to inflation is the persistence, through inertial mechanisms, of the current low inflation levels. The upside risks include frustration of the economic reform agenda, that would affect risk premia and increase inflation, and a reversion of the currently still favorable external scenario - the latter a risk that has intensified since the last meeting, according to the committee.

The Copom repeated its assessment that the economic juncture warrants an expansionary policy stance, with interest rates below their structural (read neutral) level. It also highlighted, yet again, that reforms and necessary adjustments contribute to lower estimates of the structural interest rate.

The committee decided to keep the Selic rate at 6.50%, instead of a final 25-bp cut, on the change in the balance of risks determined by a changed external scenario. The Copom communicated that an external shock must be dealt with only in its second-round effects on inflation, but argued that these shocks may change the balance of risks as they reduce the chance of inflation remaining below the target in the relevant horizon. We’ll learn more about the authorities’ thinking with the release of the Copom minutes on Tuesday, May 22, at 08:00, São Paulo time. Still, it appears that this is the bottom for the Selic and that the next movement, whenever it happens, will be up.



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