Brazil’s Central Bank has shown concern with the use of fiscal policies that seek to control inflation in the short term, stressing that the measures may have the opposite effect, of increasing prices, according to the minutes of the Monetary Policy Committee (Copom) released on Tuesday.
The minutes was seen by part of the market as harsh, although it did not give any information about the percentage of monetary tightening that will be adopted in the next meeting of the collegiate in March. It maintained the position presented in last week’s statement that it is more appropriate for the pace of the tightening cycle to be slowed.
“The particularly elevated uncertainty about prices of important assets and commodities, as well as the stage of the cycle, made the Committee consider more appropriate at this time not to signal the magnitude of its next adjustments,” said the cenbank.
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According to the monetary authority, since the last Copom meeting in December, most commodities have reverted the decrease observed at the end of the year and, in some cases, have reached recent records, reinforcing the pressured price environment.
The evaluation about the risk of using government funds to reduce product prices was presented amid the debates in the Executive and in Congress about a possible tax cut to reduce fuel prices. Proposals on the subject are already being discussed in the Legislative, with impacts that may exceed BRL 50 billion a year.
“Copom notes that even fiscal policies that have a downward effect on inflation in the short term may cause an increase in inflation expectations and, consequently, an upward effect on prospective inflation,” said cenbank.
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Last week, the central bank increased the basic interest rate by 1.50 percentage points, to 10.75% per year, but pointed to a reduced pace of adjustment in the next Copom meeting, in March, and indicated that the relevant horizon for the monetary policy includes the year 2023.
In the minutes, the cenbank also showed a revision in the forecast for the increase in administered prices, a category that includes electricity, cooking gas and urban transport. The estimate now stands at a high of 6.6% for 2022, compared to a forecast of 3.8% made in December.
“The revision was mainly due to the strong advance in petroleum prices since the last Committee meeting, as well as administered items whose oscillations are expected to repeat over the year,” cenbank said.
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According to Bank of America’s (BofA) analysis, Copom’s minutes sent a more “hawkish” message.
“Copom evaluated that its projections are above the target for 2022 and around the target for 2023. Therefore, Copom once more concluded that the monetary tightening process should be more restrictive than the one used in the reference scenario throughout the relevant horizon, which implied increasing rates to 12% in the first half of 2022, then cutting rates to 11.75% by year-end, and to 8% in 2023. It is unclear what a “tighter process” means. It could both signal a higher terminal rate, followed by cuts, or the same terminal level with an easing cycle being postponed from the reference scenario,” says BofA.
BofA reviewed the terminal Selic rate to 12.25% until May 2022 and expects cenbank to hike two more times, yet decelerating the pace: in March it should rise 1% and in May, 0.5%. BofA maintained its Selic forecast at 9.5% for 2023.
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For Marco Antonio Jacob Caruso, chief economist at Banco Original, Copom’s minutes “was what last week’s statement should have been”: clearer on the need for higher interest rates and for a longer period, to achieve inflation convergence towards the target. “Today’s minutes confirm our scenario of a terminal Selic rate of 12.25% per year, to be reached in May of this year, and emphasize the need to maintain these levels for a prolonged period,” said Caruso in a statement.
For the economist, another relevant point was the concern in explaining that, in its scenario simulations, Copom considered how long the monetary tightening will last, and not only the pace of Selic increase and its endpoint in the cycle.
Economic Scenario
The minutes stressed that the external environment remains less favorable, explaining that the greater persistence of inflation in the United States increases the risk of monetary tightening in the country, which makes financial conditions more challenging for emerging economies.
For Brazil’s cenbank, the new Covid-19 wave adds uncertainty about the pace of economic activity and may postpone the normalizing of global production chains.
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Regarding the economic activity in Brazil, the regulator said that indicators for the trade and services sectors showed a slightly better evolution than expected, while industry showed a recovery in December.
For 2022, although it notes that growth tends to benefit from the normalization of activity and the performance of agribusiness and the labor market, Copom warned about the future.
“The confidence indexes released since the last meeting continue to show deterioration, and climate events have affected the projections for important agricultural crops,” it said.
In this scenario, Copom stated that consumer inflation remains high, with disseminated increases in several components, and continues to be more persistent than anticipated.
