Itaú BBA - What to expect for the 3Q17 Inflation Report

Macro Vision

< Volver

What to expect for the 3Q17 Inflation Report

septiembre 19, 2017

We estimate declines in the inflation forecasts for 2017 and 2018.

This Thursday, the Copom monetary policy committee releases its third Inflation Report (IR) of 2017. We believe that, in line with the recent communications from monetary authorities, the IR will signal a gradual trajectory for the Selic rate, which would be consistent with a 0.75 p.p. reduction in October and, following that, a 0.50 p.p. decline in December, closing the year, and the cycle, at 7.0%. The committee also should reinforce its message that monetary policy needs to remain flexible in the face of risks of falling and rising inflation forecasts. We estimate declines in the inflation forecasts for 2017 and 2018. In the market scenario, we estimate forecast at 3.3% for 2017 and 4.4% for 2018. Meanwhile, in the hybrid scenario, where the Selic is in line with the Focus survey and exchange rates remain constant, we expect forecasts by the central bank to be 3.3% for 2017 and 4.0% for 2018. 

The Copom will publish on Thursday its Inflation Report covering the third quarter of 2017. The table below summarizes our effort to replicate the results of the central bank’s forecast model, in accordance with the market scenario (Selic and exchange rate in line with the Focus survey) and the hybrid scenario (Selic in line with Focus survey and exchange rate remaining steady). We used September 13 as the cut-off date.

For the market scenario, Focus survey forecasts point to an exchange rate of 3.20 reais per dollar in 2017 and 3.35 in 2018. For the Selic rate, survey expectations stand at 7.0% for 2017 and 7.25% in 2018. For 2017, we forecast a decline in inflation projections, to 3.3%, in line with the September meeting. For 2018, we expect a forecast of 4.4%, also in line with September minutes. 

In the hybrid scenario, we expect an inflation forecast of 3.3% in 2017, compared with 3.8% published in the previous quarterly inflation report. For 2018, we forecast inflation of 4.0%, after a figure of 4.3% in the second-quarter IR. 

It is worth noting the difference in inflation forecasts for 2018 in the market scenario and the hybrid scenario (constant exchange rate). Using market exchange rates, the 2018 inflation forecast falls close to the target, thus limiting the possibility of cuts in addition to those already accounted for in the Focus survey. 

In the text, we do not expect any message that strays in a relevant way from the previous communications from monetary authorities. We believe that, in line with the recent communiques provided by monetary authorities, the base scenario at this moment is a cut of 0.75 p.p. in October, as long as current economic conditions – that is, stabilizing economic activity amid widespread idle capacity, especially in the labor market – remain unchanged. 

In recent speeches, members of the committee have been highlighting how real interest rates have fallen to near-historic lows, which should stimulate the economy. Furthermore, the set of economic data published after the most recent monetary policy meeting in July remain consistent with a gradual recovery of economic activity. 

Looking further ahead, the committee as a whole is considering a gradual close to the easing cycle. In the minutes of the last meeting, there are few indications – with its repeated references to the end of the cycle – that could be used to support a continuation of the faster pace of easing. But the text also suggests that the Copom will not make sudden moves in the opposite direction. Members of the committee also admit that in “exceptional cases” (which they did not specify), a more intense pace could be preferable to a more gradual approach, but in general they demonstrate a preference for the latter option. This view seems to be a compromise between the dominant gradualist view and a dissident minority opinion that seemed to defend a more aggressive trajectory for the Selic rate. 

In our view, these statements indicate that the committee will likely slow the pace of monetary easing to 0.75 p.p. in the October meeting, to be followed by another cut of 0.50 p.p., with the Selic rate ending the year, and the cycle, at 7.0%. 

Another important point, likewise stressed in the minutes, is the message that monetary policy should remain flexible in order to deal with the risks of declines and increases in inflation forecasts. The committee notes that a favorable continuous shock in the prices of food and in manufacturing could have secondary effects on inflation. Furthermore, inertial mechanisms could increase the persistence of current low inflation levels moving forward. On the other hand, frustration linked to the progress of reforms could affect risk premiums and increase inflation in the horizon pertinent to monetary policy, a risk that would become more intense should the favorable external environment deteriorate. Therefore, the IR should highlight that, although the 7.0% level for the Selic will likely be the final level during the cycle, changes in the environment could lead the Copom to stray somewhat from this level. 

 



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