Brazil holds rate 3rd time, signals end of f’ward guidance

December 10, 2020
Brazil’s central bank left its benchmark interest rates steady for the third month and while it acknowledged inflation is higher than expected, it still considers the rise temporary and with inflation expectations for 2022 around its target, the recently-adopted forward guidance may no longer be needed.
     The Central Bank of Brazil (BCP) left its benchmark Selic interest rate at 2.0 percent, unchanged since September when it paused in its easing cycle after 21 rate cuts in almost four years.
     This year the rate has been cut five times by a total of 250 basis points and since October 2016 the rate has been cut 12 percentage points.
     The central bank’s monetary policy committee confirmed the current level of “unusually strong monetary stimulus,” which is being provided by the current interest rate, is adequate amid the uneven economic recovery and larger-than-usual uncertainty about economic growth in light of the expected unwinding of the government’s emergency transfer programs.
      In August the central bank’s policy committee Copom adopted the policy of forward guidance, now used by many central banks worldwide, saying it did not foresee any reductions in the monetary stimulus unless inflation expectations and its own forecast were sufficiently close to the target.
      Copom said these conditions for the forward guidance are still being met and despite a higher-than-expected rise in inflation, it still considers this rise as temporary but is monitoring the situation closely.
      And even if inflation expectations, especially for 2021, have risen, they remain below the target, the fiscal regime hasn’t changed and long-term inflation expectations remain well anchored.
      Brazil’s headline inflation rate rose to 4.31 percent in November, the highest since December 2019, and while it is above the central bank’s midpoint inflation target of 4.0 percent it is still within its range of 2.5 to 5.5 percent.
      Copom’s view of inflation mirrors last month’s statement by its president, Roberto Campos Neto, who said policymakers should look through the temporary factors pushing up prices, such as a spike in food prices, a weak exchange rate and demand fueled by the government’s emergency income transfers.
     But the steady rise in inflation has begun to filter into inflation expectations, with economists in the bank’s latest FOCUS survey from Dec. 4 expecting 4.2 percent inflation for 2020.
     But in 2021 and 2022 inflation is seen easing to 3.3 percent and 3.5 percent, respectively.
     In 2021 the central bank will target inflation at a midpoint of 3.75 percent and in coming months inflation expectations for 2021 will become less relevant than those for 2022, BCB said.
     Since adopting the forward guidance, the previous declining trend in inflation expectations was reversed but Copom said even if the conditions for the forward guidance may soon no longer apply, this
“does not mechanically imply interest rates increases, since economic conditions still prescribe an extraordinarily strong monetary stimulus.”
     And in the event the forward guidances no longer applies, Copom said its monetary policy will still follow the inflation-targeting framework.
      The last two FOCUS surveys show that economists expect the Selic rate to rise by 100 basis points to 3.0 percent, up from 2.75 percent previously.
      Copom said its own projections also assumes the Selic rate would rise to 3.0 percent in 2021, then 4.50 percent in 2022.
     After falling sharply at the start of this year, Brazil’s real has slowly gained strength since mid-May and  has risen steadily since Nov. 1.
Today the real was trading at 5.17 to the U.S. dollar, up 14 percent since a record low of around 5.89 on May 14 but still down almost 23 percent since the start of 2020.
     Brazil’s economy has contracted in the last three quarters, with gross domestic product down 3.9 percent year-on-year in the third quarter after a 10.9 percent drop in the second quarter and a 0.3 percent fall in the first quarter.
     On Dec. 1 the International Monetary Fund forecast Brazil’s economy would shrink 5.8 percent this year and then grow 2.8 percent in 2021 while inflation will remain below target until 2023 given the slack in the economy.

The Central Bank of Brazil  issued the following statement:

“In its 235th meeting, the Copom unanimously decided to maintain the Selic rate at 2.00% p.a.

The following observations provide an update of the Copom’s baseline scenario:

·      Regarding the global outlook, the pandemic resurgence in some major economies is reversing previous mobility gains and should affect short-term activity. However, promising results in COVID-19 vaccine trials tend to improve confidence and growth in the medium term. Economic slack and central bank communication from major economies suggest monetary stimuli will last long, resulting in a favorable environment for emerging economies;

·      Turning to the Brazilian economy, recent indicators suggest the uneven recovery in economic activity continues, as expected. However, prospectively, uncertainty about economic growth remains larger than usual, especially for the period starting at the end of this year, concurrently with the expected unwinding of the emergency transfer programs;




·      The latest inflation readings were higher than expected and, despite the predicted retraction of food price pressures, December inflation should still remain elevated. In spite of the stronger short-term inflationary pressure, the Committee maintains the diagnosis that the current shocks are temporary, but continues to monitor closely its evolution, in particular the core inflation readings;

·      The various measures of underlying inflation are in levels compatible with meeting the inflation target at the relevant horizon for monetary policy;

·      Inflation expectations for 2020, 2021, and 2022 collected by the Focus survey are around 4.2%, 3.3%, and 3.5%, respectively;

·      The Copom’s inflation projections in its baseline scenario, with interest rate path extracted from the Focus survey and exchange rate starting at R$5.25/US$* and evolving according to the purchase power parity (PPP), stand around 4.3% for 2020, 3.4% for 2021 and 3.4% for 2022. This scenario assumes a path for the Selic rate that ends 2020 at 2.00% p.a., rises to 3.00% p.a. in 2021 and 4.50% p.a. in 2022; and

·      The scenario with constant interest rate at 2.00% p.a. and exchange rate starting at R$5.25/US$* and evolving according to the PPP yields inflation projections around 4.3% for 2020, 3.5% for 2021 and 4.0% for 2022.

The Committee emphasizes that risks to its baseline scenario remain in both directions.

On the one hand, economic slack may continue to produce a lower-than-expected prospective inflation trajectory, especially when the slack is concentrated in the service sector. This risk increases if a slower reversion of the pandemic effects lengthens the environment of high uncertainty and precautionary savings.

On the other hand, an extension of fiscal policy responses to the pandemic that aggravate the fiscal path or a frustration with the continuation of the reform agenda may increase the risk premium. The relative increase in the risks of these events imply an upward asymmetry to the balance of risks, i.e., in the direction of higher-than-expected paths for inflation over the relevant horizon for monetary policy.

The Committee believes that persevering in the process of reforms and necessary adjustments in the Brazilian economy is essential for a sustainable economic recovery. The Copom also stresses that uncertainty regarding the continuation of the reform agenda and permanent changes to the fiscal consolidation process could result in an increase in the structural interest rate.

Taking into account the baseline scenario, the balance of risks, and the broad array of available information, the Copom unanimously decided to maintain the Selic rate at 2.00% p.a. The Committee judges that this decision reflects its baseline scenario for prospective inflation, a higher-than-usual variance in the balance of risks, and it is consistent with the convergence of inflation to its target over the relevant horizon for monetary policy, which includes 2021 and 2022.

The Committee deems as adequate the current level of unusually strong monetary stimulus, which is being provided by the maintenance of the policy rate at 2.00% p.a. and the forward guidance introduced in the 232nd meeting. The forward guidance stated that the Copom does not intend to reduce the monetary stimulus as long as specified conditions are met. The Committee judges that those conditions continue to hold. In spite of having increased since the last meeting, in particular for 2021, inflation expectations, as well as inflation projections for its baseline scenario, are still below the inflation target for the relevant horizon for monetary policy; the current fiscal regime has not been changed; and long-term inflation expectations remain well anchored.

The Copom judges that, since adoption of the forward guidance, inflation expectations reversed their declining trend relative to the target for the relevant horizon. Additionally, over the next months, the 2021 calendar-year should become less relevant than the 2022 calendar-year, for which projections and expected inflation are around the target. A scenario of inflation expectations converging to the target suggests that the conditions for maintaining the forward guidance may soon no longer apply, which does not mechanically imply interest rates increases, since economic conditions still prescribe an extraordinarily strong monetary stimulus. In case the forward guidance ceases to apply, monetary policy will follow the inflation target framework, based on the analysis of prospective inflation and its balance of risks.

The following members of the Committee voted for this decision: Roberto Oliveira Campos Neto (Governor), Bruno Serra Fernandes, Carolina de Assis Barros, Fabio Kanczuk, Fernanda Feitosa Nechio, João Manoel Pinho de Mello, Maurício Costa de Moura, Otávio Ribeiro Damaso, and Paulo Sérgio Neves de Souza.”

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