Brazil‘s Central Bank increased the pace of monetary tightening on Wednesday when it lifted its benchmark Selic rate to 5.25% from 4.25%, indicating it will repeat the dose in September in light of inflationary pressures.
Previously, the communication from the Central Bank highlighted that the process of adjustments in the Selic aimed at the normalization of the interest rate towards neutrality.
The bank’s rate-setting committee – known as Copom – said it “considers that, at this moment, the strategy of being more timely in adjusting monetary policy is the most appropriate to ensure the anchoring of inflation expectations.”
“At this time, the basic scenario and Copom’s balance of risks indicate that a cycle of interest rate hikes above neutral is appropriate,” the statement added.
That was Copom’s fourth hike in a row, and its largest since its last 100-basis point increase to 26.50% in February, 2003.
When it began raising the Selic in March, after leaving it at a historic low of 2 percent for four straight meetings, the Central Bank signaled that it was seeking a partial normalization of the rate, thus reducing the stimulus it sought to inject into the economy after the crisis with the coronavirus pandemic led activity to suffer a record slump last year.
But already in June, when it met for the last time, the Copom started to indicate that it had in sight the normalization of the interest rate to the level considered neutral, in which the Selic neither heats nor cools the economy. This level is around 6.5%, according to the Central Bank’s own indication.
Persistent Inflation in Brazil
The change came in the wake of renewed inflationary pressures, driven by higher fuel and electricity prices.
According to the Brazilian Central Bank, consumer inflation continues to prove persistent.
“The latest released indicators show a more unfavorable composition. Noteworthy is the surprise with the underlying component of services inflation and the continued pressure on industrial goods, causing the cores to rise,” it said.
“In addition, there are new pressures in volatile components, such as the possible increase in the additional tariff flag and new increases in food prices, both arising from adverse weather conditions. Together, these factors lead to a significant revision of short-term projections,” he added.
Together with a stronger economic recovery, the scenario had already made many economic agents bet that the Central Bank, in Wednesday’s decision, would show its intention to take interest rates beyond the neutral level to tame inflation expectations for next year, a horizon that currently carries more weight in its monetary policy decisions.
In its communiqué, the Central Bank maintained its forecasts for the inflation index IPCA in 2022, according to its basic scenario, at 3.5%, indicating inflation at 3.2% for 2023. For this year, the Central Bank raised its inflation estimate to 6.5%, from 5.8% previously.
The center of the inflation target is 3.75% for 2021, 3.5% for next year, and 3.25% for 2023, always with a margin of tolerance of 1.5 points more or less.
In cenbank’s Focus Bulletin, the prospects are worse, with the IPCA at 6.79% this year, 3.8% in 2022, and 3.25% in 2023. Unlike the Central Bank, therefore, the market already sees inflation above the center of the target next year.
Considered a preview of official inflation, the index rose 0.72% in July, the highest for the month since 2004, with the accumulated figure over 12 months reaching 8.59%.
Concerning the dynamics of the economic recovery, the Central Bank evaluated that the latest indicators continue showing a positive evolution and do not suggest any relevant change for the scenario ahead, which contemplates a robust recovery over the second half of the year.
At the end of June, the Central Bank had announced a GDP growth expectation of 4.6% this year. According to Focus survey, the market already sees an expansion of 5.3% for the activity.
Brazilian fiscal risk
Although concerns with the direction of public accounts have moved the market in recent days, the Central Bank did not make new considerations on the subject, limiting itself to repeat in the statement messages that had already been hammered out, including that the high fiscal risk continues to create an asymmetry high in the balance of risks to inflation.
President Jair Bolsonaro has made constant nods that he will increase the Bolsa Familia social transfers benefit despite there being no formal definition on how this will occur, especially after the disclosure of a bill for about R$90 billion in payment requests issued by the Justice after definitive defeats suffered by the government in lawsuits to be paid by Brazil‘s government next year.
Faced with the challenge, the economic team wants to approve in Congress a Proposal of Amendment to the Constitution (PEC, in Portuguese) that allows the installment payment of these payment requests. With this, the proposal would open space in the government’s budget to accommodate other expenses, including a more robust Bolsa Família.
Part of the economic agents, however, see the onslaught as a kind of deadbeat, with the government seeking to dig budget gaps to make more expenses in an election year.
(Translated by LABS)