Brazil Flash Report: Central Bank rises basic interest rate, more to come.
The Monetary Policy Committee (COPOM) decided to rise basic interest rate in 1.5 bps, in line with market expectations, rising the SELIC to 7.75 %, above it’s pre-pandemic level (6 %). The Central Bank had promised only a 1 bp. rise in its last meeting at September 22nd, but the deterioration in the domestic and external outlook demanded a more “hawkish” action. At the external sector, the rising of inflation in several developed countries will demand action by the Central Banks, tightening the monetary liquidity, leading to a more challenging outlook for emerging economies.** Moreover, shortages in the supply chains around the world will damage growth in several economies this year.**
Inflation persistence is also surprising in Brazil. The inflation rose to 10.25 % and indicates that it will continue to be pressed by oil and electricity prices and the recovery of services prices. We all know inflation will be well above Central Bank target in 2021 (3.75%) but expectations for 2022, currently at 4.4 %, are also above the 3.5 % target, indicating that a contractionary monetary policy is the correct measure to take inflation expectations back to its target.
Recent news suggests that Brazil loosed the credibility of its main fiscal anchor, the spending ceiling. As government tries to review the parameters of the Fiscal rule so it can accommodates a new cash transfer policy, it is signaling that the government is not committed to the fiscal adjustment, increasing Brazilian risk premiums. This means that the “theoretically” neutral interest rate will rise.
The Committee signalled that it will raise the SELIC on another 1.5 bps on its next reunion in December 7th, stating that monetary policy has to enter in more contractionary ground. The terminal interest rate is quite unclear yet, 2022 will be an election year and there will be pressure to higher spending, which might possibly deteriorate even more the fiscal outlook. We believe Central Bank will terminate its adjustment at 11.5 % with upside risks to this scenario.
