Wednesday, February 5, 2020

Brazil cuts rate 25 bps but says time to interrupt easing

    Brazil's central bank cut its benchmark Selic interest rate by 25 basis points to a record low of 4.25 percent but said it is now "appropriate to interrupt the monetary easing process" in light of the lagged effects of the rate cuts that began in July 2019.
    The Central Bank of Brazil (BCB) has cut its rate 5 times since July last year by a total of 225 basis points.
     Since October 2016, when it first embarked on an easing cycle, the Selic rate has been cut 17 times and by a total of 10 percentage points.
     As in December, BCB said "caution" in monetary policy was still recommended in the current business cycle and the next move would be data dependent, linked to economic activity, the balance of risks and inflation, with increasing weight given to 2021.
     "Data on economic activity released since the previous meeting indicate the continuation of the process of gradual economic recovery," BCB said, adding underlying inflation is at a level that is compatible with meeting its inflation target.
     BCB began cutting rates in October 2016 and cut them 12 times through March 2018 by a total of 775 basis points.
     But by early 2018 Brazil's real began depreciating as the U.S. Fed was tightening, putting upward pressure on Brazil's inflation rate, which topped 4 percent from June through November 2018.
     BCB therefore kept its rate steady for more than a year until July 2019 when inflationary pressures again began to ease, helped by a rise in the real from May through July.
    A brief period of appreciation by Brazil's real came to a halt in August last year and since then it has continued to depreciate to record lows.
      Today it was trading at 4.24 to the U.S. dollar, slightly up from a record low of 4.28 on Friday, but still down 5.2 percent this year.
      Despite the fall in the real, inflationary expectations have remained in check, with this week's survey of economists by the central bank showing 2020 inflation expectations falling to 3.40 percent from the previous 3.47 percent, below BCB's 4.0 percent target.
      In January Brazil's inflation rate was largely stable at 3.78 percent from December's 3.75 percent, despite higher meat prices,
      But accelerating economic growth is expected to slowly put upward pressure on inflation with BCB seen switching to a tightening stance and raising the Selic rate to an average of 6.25 percent in 2021, according to this week's survey.
      After a recession in 2016, Brazil's economy is slowly recovering and gross domestic product only grew 1.2 percent year-on-year in the third quarter, up from 1.1 percent in the second quarter.
      But helped by last year's passage of pension reform and an expected overhaul of the tax system and other reforms, economists are turning optimistic about the country's growth prospects.
      In December BCB raised its forecast 2020 growth to 2.2 percent from an earlier 1.8 percent.
      Recent surveys confirm Brazil's expansion, with the IHS Markit Brazil Composite PMI rising to 52.2 in January from 50.9 in December, the strongest expansion of the private sector in four moths.
      The survey showed manufacturing output grew to 51 from 50.2 while services expanded at the fastest pace in nearly a year, rising to 52.7 from 51 in December.

     The Central Bank of Brazil issued the following statement:

"In its 228th meeting, the Copom unanimously decided to lower the Selic rate to 4.25% p.a.
The following observations provide an update of the Copom's baseline scenario:
Data on economic activity released since the previous meeting indicate the continuation of the process of gradual economic recovery;
Regarding the global outlook, despite the recent increase in uncertainty, the provision of monetary stimulus in major economies has been able to generate relatively favorable environment for emerging economies;
The Committee judges that various measures of underlying inflation are running at 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 3.4%, 3.75%, and 3.5%, respectively;
The Copom's inflation projections in the hybrid scenario with interest rate path extracted from the Focus survey and constant exchange rate at R$4.25/US$* stand around 3.5% for 2020, and 3.7% for 2021. This scenario assumes a path for the Selic rate that ends 2020 at 4.25% p.a. and rises to 6.00% p.a. in 2021; and
The scenario with constant interest rate at 4.50% p.a. and constant exchange rate at R$4.25/US$* yields inflation projections around 3.5% for 2020, and 3.8% for 2021.
The Committee emphasizes that risks to its baseline scenario remain in both directions. On the one hand, (i) the high level of economic slack may continue to produce a lower-than-expected prospective inflation trajectory. On the other hand, (ii) the current degree of monetary stimulus, which affects the economy with lags, may produce a higher-than-expected path for inflation over the relevant horizon for the conduct of monetary policy. Risk (ii) intensifies in case of (iii) an increase in the monetary policy power due to the changes in credit and capital markets, (iv) a deterioration of the outlook for emerging economies, or (v) a possible frustration with the continuation of reforms and the perseverance in the necessary adjustments in the Brazilian economy.
Taking into account the baseline scenario, the balance of risks, and the broad array of available information, the Copom unanimously decided to lower the Selic rate to 4.25% p.a. The Committee judges that this decision reflects its baseline scenario for prospective inflation and the associated balance of risks, and it is consistent with convergence of inflation to its target over the relevant horizon for the conduct of monetary policy, which includes 2020 and, with increasing weight, 2021.
The Copom reiterates that economic conditions prescribe stimulative monetary policy, i.e., interest rates below the structural level.
The Copom sees progress in the process of reforms and necessary adjustments in the Brazilian economy. The Committee emphasizes that persevering in this process is essential to allow for the consolidation of the reduction of the structural interest rate and for a sustainable economic recovery. The Copom stresses that the perception of the continuation of the reform agenda affects current expectations and macroeconomic projections.
The Copom judges that the current stage of the business cycle recommends caution in the conduct of monetary policy. In light of the lagged effects of the monetary easing cycle that began in July 2019, the Committee deems appropriate to interrupt the monetary easing process. The Committee emphasizes that its next steps will continue to depend on the evolution of economic activity, the balance of risks, and inflation projections and expectations, with increasing weight for 2021.
The following members of the Committee voted for this decision: Roberto Oliveira Campos Neto (Governor), Bruno Serra Fernandes, Carolina de Assis Barros, Fábio 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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