Wednesday, March 17, 2021

Brazil raises rate 75 bps and sees another hike in May

     Brazil's central bank joined the growing number of central banks that are responding to rising inflation by raising its key interest rate for the first time in six years and said it expects to raise its rate again in May unless there is a significant change in inflation projections.
    The Central Bank of Brazil (BCB) raised its benchmark Selic interest rate by 75 basis points to 2.75 percent - more than expected by most analysts - in its first rate hike since July 2015 as it began what it said was a "partial normalization process" to reduce the extraordinary degree of monetary stimulus.
     Looking ahead to its next meting, the bank's monetary policy committee Copom - which was unanimous in its decision - said it expects to continue normalizing its policy and raise the rate by the same amount when it next meets in early May.
     Although the rate hike was widely expected due to rising inflation, the monetary tightening represents an important shift in the central bank's view of the outlook for inflationary pressures.
      At its previous meeting on Jan. 20, Copom's statement acknowledged rising price pressures but maintained price shocks were temporary and underlying inflation was in line with its inflation target.
     But the minutes from its meeting released on Jan. 26 revealed that some of the members of Copom were starting to consider trimming the extraordinary stimulus released during the COVID-19 pandemic in light of the economy's improvement.
     The rate hike comes after a monetary easing cycle with 21 rate cuts beginning in October 2016 that ended in September 2020 after 5 rate cuts last year to aid the economy from the pandemic.
     The central bank's first gentle tilt toward tightening then arose in December last year when Copom said its forward guidance from August - which said it didn't foresee any reduction in monetary stimulus unless inflation expectations approached the inflation target - may no longer be needed.
      Brazil's rate hike comes on the same day Georgia's central bank also raised its rate to curb inflationary pressures and 10 central banks have now raised their interest rates this year, with Brazil the first major emerging market central bank to make the tightening move.
      In addition to Georgia, the other central banks that have raised rates this year include Mozambique, Armenia, Tajikistan, Zambia, Zimbabwe, Kyrgyzstan and Ukraine, countries that are more susceptible than developed markets to inflationary pressures from food prices and exchange rate movements.
      Denmark, a developed market central bank, raised its rate last week but this was mainly a technical adjustment of its monetary policy tools to smooth out fluctuations in money market rates.
     By tightening its policy faster than expected by most analysts - who had pencilled a 50 basis point rate rise - Brazil's Copom said a faster reduction in the amount of stimulus would improve the odds of meeting its inflation target in 2021, help anchor inflation expectations and is compatible with meeting the inflation target in 2022.
     Brazil's inflation rate has been accelerating since September last year and rose to 5.2 percent in February from 4.56 percent in January, at the top end of the bank's 2021 inflation target of 3.75 percent, plus/minus 1.50 percentage point.
     "The various measures of underlying inflation are in levels above the range compatible with meeting the inflation target," BCB said, adding inflation expectations from the Focus survey of economists are now around 4.6 percent for 2021 - the 10th rise in a row - and 3.5 percent for 2022, and 3.25 percent for 2023.
     On top of rising prices for commodities and food, Brazil's inflation rate has been propelled higher by a weak currency, which pushes up import prices.
     Last year Brazil's real fell 30 percent against the U.S. dollar and this year it has fallen another 7 percent to trade at 5.58 today, with the central bank intervening in the foreign exchange market both last month and earlier this month.

     The Central Bank of Brazil issued the following statement:

"In its 237 th  meeting, the Copom unanimously decided to increase the Selic rate to 2.75% pa

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

· Regarding the global outlook, new fiscal stimuli in some developed countries and the advancement of the COVID-19 immunization programs should promote a more robust economic recovery throughout the year. Economic slack and central bank communication from major economies suggest monetary stimuli will last long. However, market discussion regarding inflationary risks in these economies, and the associated repricing of financial assets, could result in a more challenging environment for emerging economies;

· Turning to the Brazilian economy, recent indicators, particularly the GDP growth in the fourth quarter of 2020, continued to suggest a consistent economic recovery in spite of the reduction in the emergency income transfers. However, these readings do not capture the effects of the recent increase in the number of COVID-19 cases. Prospectively, uncertainty about economic growth remains larger than usual, especially for the first and second quarters of this year;

· The continuing increase in commodities prices, measured in local currency, are affecting current inflation and triggered additional increases in inflation forecasts for the next months, especially through its effects on fuel prices. In spite of these stronger and more persistent than expected short-term inflationary pressures, the Committee maintains the diagnosis that the current shocks are temporary, but continues to closely monitor its evolution;

· The various measures of underlying inflation are in levels above the range compatible with meeting the inflation target;

· Inflation expectations for 2021, 2022, and 2023 collected by the Focus survey are around 4.6%, 3.5%, and 3.25%, respectively; and

· The Copom's inflation projections in its baseline scenario, with interest rate path extracted from the Focus survey and exchange rate starting at R $ 5.70 / US $ * and evolving according to the purchase power parity (PPP), stand around 5.0% for 2021 and 3.5 % for 2022. This scenario assumes a path for the Selic rate that ends 2021 at 4.50% pa and rises to 5.50% pa in 2022. In this scenario, inflation projections for administered prices are 9.5% for 2021 and 4.4% for 2022.

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

On the one hand, the worsening of the pandemic may delay the economic recovery, producing a lower-than-expected prospective inflation trajectory.

On the other hand, an extension of fiscal policy responses to the pandemic that aggravates 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, ie , 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 increase the Selic rate by 0.75 pp to 2.75% pa 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, mainly, 2022.

The Copom members consider that the current conditions ceased to prescribe an extraordinarily stimulus. GDP ended 2020 growing strongly at the margin, recovering most of its first-semester decline, and inflation expectations rose above target at the relevant horizon for monetary policy. Additionally, inflation projections increased to levels close to the upper bound of the target for 2021.

Therefore, the Copom decided to start a process of partial normalization by reducing the extraordinary degree of monetary stimulus. For all the aforementioned reasons, the Committee considered appropriate an adjustment of 0.75 pp in the Selic rate. In the Committee's evaluation, a swifter adjustment has the benefit of reducing the probability of not meeting the inflation target in 2021, as well as of keeping longer horizon expectations well anchored. Additionally, the broad set of information available to the Committee suggests that this strategy is consistent with meeting the 2022 inflation target, even if social distancing increases temporarily.

For the next meeting, unless there is a significant change in inflation projections or in the balance of risks, the Committee foresees the continuation of the partial normalization process with another adjustment, of the same magnitude, in the degree of monetary stimulus. The Copom emphasizes that its view for the next meeting will continue to depend on the evolution of economic activity, the balance of risks, and inflation projections and expectations.

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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