Brazil raises rate 2nd time and sees another hike in June

     Brazil's central bank raised its benchmark interest rate for the second time this year, as widely expected, and said it expects to raise its rate by the same amount at its next policy meeting as it continues to partially normalize its monetary policy stance.
     The Central Bank of Brazil (BCB) raised its Selic rate by another 75 basis points to 3.50 percent and has now raised it by 150 points this year following a similar-sized hike in March.

     "For the next meeting, the Committee foresees the continuation of the partial normalization process with another adjustment of the same magnitude in the degree of monetary stimulus," the bank's policy committee Copom said after a unanimous decision.

     The next meeting by Copom is scheduled for June 16.

     Despite a recent slowing in economic activity during a second wave of COVID-19, BCB said recent data had been better than expected and while uncertainty over economic growth remains larger than usual, growth should gradually return to normal.

     Today's rate hike was well-telegraphed, both by the bank's president, Roberto Campos Neto, and by Copom.

     In March BCB raised its Selic rate by 75 basis points in the first rate hike since July 2015 as it began what it said was a "partial normalization process" to reduce the extraordinary degree of stimulus. Copom said it would continue this normalization today and raise the rate by the same amount. 

     Bank officials have said the reference to "partial" normalization means the Selic rate will be raised aggressively early in the tightening cycle

     Last month Campos Neto reinforced Copom's message, saying the rate would be raised another 75 basis points at today's meeting unless something extraordinary happens.

     The two rate hikes follow a monetary easing cycle that included 21 rate cuts between October 2016 and September 2020, including 5 cuts in response to the pandemic.
     The first gentle shift toward tightening came in December last year when Copom altered its guidance and since then Brazil's inflation rate has continued to accelerate and is now above the bank's upper limit of its target range of 2.25 - 5.25 percent around a 3.75 percent midpoint.

     In March Brazil's inflation rate rose for the 10th month in a row to 6.1 percent from 5.2 percent in April - the highest since December 2016 - spurring economists in the bank's latest FOCUS survey to raise their 2021 inflation forecast to 5.0 percent from 4.9 percent.

     The survey also showed economists raised their forecast for Selic to end the year at 5.50 percent from 5.0 percent.

     For 2022 economists raised their inflation forecast to 3.6 percent from 3.5 percent.

     As seen across the world, rising food and commodity prices, including oil, is putting upward pressure on inflation, with a decline in the exchange rate of Brazil's real since 2019 adding further pressure.

     Although the real has firmed in the last two months, it has not recaptured pre-pandemic highs.

     The real was trading at 5.37 to the U.S. dollar today, up almost 10 percent since early March but still down 3.4 percent since the start of this year and 25 percent lower than the start of 2020.

     The rise in price pressures rise comes amid a slowdown in economic activity from a rise in COVID cases since March. Although daily cases have eased since late March, they remain higher than in the first wave last summer and deaths recently surpassed 410,000 for the 3rd highest total in the world following the U.S. and India.

      In April the IHS Markit Composite PMI eased to 44.5 in April from 45.1 in March, the fourth straight contraction, with business sentiment also the weakest since June 2020.

     BCB has been clear it is trying to strike a balance between curbing inflation while still ensuring the economic recovery continues.

     Brazil's gross domestic product shrank 4.1 percent last year, the steepest drop since records began in 1996 and the central bank has forecast 3.6 percent growth this year.

     The Central Bank of Brazil issued the following statement:

"In its 238 th meeting, the Copom unanimously decided to increase the Selic rate to 3.50% 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 could result in a more challenging environment for emerging economies;

· Turning to the Brazilian economy, recent indicators are evolving better than expected in spite of the second wave of the pandemic being more intense than anticipated. Prospectively, uncertainty about economic growth still remains larger than usual, but should gradually return to its normal level;

· With the exception of oil, commodity prices continued to increase, impacting food and industrial price forecasts. Additionally, the transition to higher energy prices should keep inflation under pressure in the short run. 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 at the top of the range compatible with meeting the inflation target;

· Inflation expectations for 2021, 2022, and 2023 collected by the Focus survey are around 5.0%, 3.6%, 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 $ 5.40 / US $ * and evolving according to the purchase power parity (PPP), stand around 5.1% for 2021 and 3.4 % for 2022. This scenario assumes a path for the Selic rate that ends 2021 at 5.50% pa and rises to 6.25% pa in 2022. In this scenario, inflation projections for administered prices are 8.4% for 2021 and 5.0% for 2022.

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

On the one hand, economic recovery from the pandemic can be slower than estimated, producing a lower-than-expected prospective inflation trajectory.

On the other hand, further extensions of fiscal policy responses to the pandemic that aggravate the fiscal path, or a frustration with the continuation of the reform agenda, may add pressure to the country risk premium. The elevated fiscal risk creates an upward asymmetry in the balance of risks, ie , in the direction of higher-than-expected paths for inflation over the relevant horizon for monetary policy.

The Committee reiterates 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 3.50% 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 2022. Without compromising its fundamental objective of price stability, this decision also implies smoothing of economic fluctuations and fosters full employment.

At this moment, the Copom's baseline scenario indicates that a partial normalization of the policy rate remains appropriate to keep some degree of monetary stimulus during the economic recovery. However, the Committee emphasizes that there is no commitment with this plan, and that future steps of monetary policy could be adjusted to assure the achievement of the inflation target.

For the next meeting 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 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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