08/08/2023 – 10:46 am
The Monetary Policy Committee (Copom) of the Central Bank reaffirmed this Tuesday, the 8th, in the minutes of its meeting this month, that the improvement in the inflationary scenario combined with the drop in inflationary expectations in longer terms “allowed to accumulate the necessary confidence to initiate a gradual cycle of monetary easing”. Last week, the Copom started the Selic easing cycle with a drop of 0.50 percentage points, from 13.75% to 13.25% a year, after a year of stability.
According to the committee, the improvement in the inflation scenario partly reflects the lagged effects of monetary policy after the biggest cycle of interest rate hikes in Copom’s history. In the case of the fall in long-term expectations, the BC points out that it was after the National Monetary Council (CMN) decided to maintain the inflation target at 3.0% for the coming years.
In the minutes, as in the statement, the monetary authority also updated the balance of risks for inflation, which continues with the same number of factors for upside and downside threats.
Among the upside risks, the Central Bank cited greater persistence of global inflationary pressures; and brought as a novelty a greater resilience in services inflation than projected due to a tighter output gap. At the previous meeting, in June, there were three upside risks and two of them are no longer present in the BC’s current scenario: the “residual” risk on the design of the fiscal framework and the chance that discouragement will be greater or longer lasting.
Among the downside risks, the BC highlights a more pronounced deceleration in global economic activity than projected, in particular due to adverse conditions in the global financial system; and the risk that the impacts of synchronized monetary tightening on global disinflation prove stronger than expected. In June, there were risks of further declines in commodity prices and a greater credit slowdown than was consistent with the monetary policy cycle.
Both options compatible
After a split decision on the first cut in the Selic rate, the Copom clarified, in the minutes of last week’s meeting, that the collegiate considered that there was merit in both an initial reduction in the Selic rate of 0.25 percentage points and a 0.50 point percentage.
In addition, it evaluated that both options would be compatible with the convergence of inflation to the target, depending on the cycle that was undertaken. “Both options, depending on the cycle undertaken, would be compatible with the convergence of inflation to the target both in the Committee’s reference scenarios and in other scenarios presented at the meeting.”
On the other hand, there was also a consensus that, whatever the decision, a scenario with inflation expectations with only partial re-anchoring, core inflation still above the target, service inflation above the level compatible with the target for inflation and economic activity A resilient policy requires a more conservative stance throughout the monetary policy easing cycle.
Last week, the Copom began the Selic easing cycle with a drop of 0.50pp, from 13.75% to 13.25% per year, after a year of stability – which generated surprise in part of the market, especially against the official inflation projection for 2024, of 3.4%, above the 3.0% target. The decision was split, with 5 directors voting in favor of 13.25% and four for 13.50%.
According to the minutes, the minority group defended a more parsimonious reduction in the interest rate, as indicated in the previous Copom, in June, since there was no relevant change in the scenario to justify the change. “For this group, the Committee’s own signaling already emphasized caution and parsimony in such a situation and, in the opinion of these members, no relevant changes were observed in the Committee’s scenario or projections that would justify a reassessment of this signaling”, explained the BC.
The more aggressive wing, however, highlighted that the significantly contractionary level of monetary policy would allow starting the cycle of Selic cuts already at the moderate pace considered for the next meetings, “without detriment of the commitment with the target and the credibility of the monetary policy”.
“This group emphasized some developments since the last meeting, such as the recent dynamics of more benign inflation than expected, the relatively quick partial re-anchoring after the CMN defined the target and the adequacy of recalibrating the real interest rate in light of movements in inflation expectations”, informed the minutes.
Credibility
Faced with market fears that the Copom will become more lenient with the fight against inflation as new members appointed by the Lula government enter, the collegiate had a “unanimous” understanding that the BC’s credibility and reputation must be guaranteed in any board formation. This understanding was built with the participation of two of Lula’s chosen members in the collegiate: Gabriel Galípolo and Ailton Aquino.
This assessment was made in the midst of the committee’s discussion on the factors that could explain the partial de-anchoring of inflation expectations even after the CMN’s decision to maintain the inflation target at 3.0% in the coming years and to announce the change in the calendar year to continuous goal. “The hypothesis of agents’ perception that, over time, the Central Bank could become more lenient in combating inflation was mentioned. There was a unanimous understanding that, regardless of the composition of the collegiate board over time, the credibility and reputation of the Institution must be guaranteed.”
Among the other factors mentioned for even partial re-anchoring in longer terms was the uncertainty that still persists among agents about overcoming the fiscal challenges, evidenced in the expectations of the primary result that diverge from the targets established by the government. “The Committee removed from its balance of risks the residual uncertainty about the approval of the fiscal framework, but, in its discussion, noted that fiscal dynamics continued to be relevant in its baseline scenario.”
In this case, it was considered that “the anchoring of expectations around the targets set out in the new fiscal framework, with the maintenance of the external fiscal commitment, in addition to a reduction of uncertainties about the tax measures that underlie the execution would contribute to a faster disinflationary process.” of such a goal”. The phrase alludes to the uncertainty about the additional revenues that the Ministry of Finance will have to obtain to reach the objective of a neutral primary result in 2024.
A global scenario of higher inflation was also mentioned by other Copom members as a possible explanation for the lack of anchorage still observed in expectations, since there is the possibility of external inflation at higher levels for a prolonged period.
Regarding the partial re-anchoring after the CMN, the Copom emphasized the gain in credibility produced by the decision to maintain the target at 3.0% in 2026, without changing the bands or objectives already defined for previous years. In addition, the committee considered that the announcement of adoption of the continuous target, which will still have the established rules, “reduced the uncertainty about the targets for subsequent years, also contributing to greater re-anchoring”. “There was, therefore, a positive impact on inflation expectations shortly after the CMN’s decision, reinforcing the interpretation of the credibility gain of the inflation targeting regime.”
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