Q: William, we recently had a sizeable Brazilian rate hike. Is this the start of an aggressive tightening cycle?
A: Yes and no. The record shows that monetary tightening cycles in Brazil tend to be fairly aggressive – in the last six, the Selic rate rose by an average of about 500bp. This time round, we see room for another 200bp of hikes (on top of the 75bp hike already delivered), which is much more than we’re expecting anywhere else this year. On the other hand, our forecasts imply that the cycle will smaller and shorter than most currently anticipate – the widespread view now is that there might be as much as a further 275bp of hikes this year, and more in 2022.
Q: What’s driving this move to tighten monetary policy?
A: Problems for Brazil’s central bank have really started to mount in the last few months. Inflation has risen sharply, inflation expectations have started to drift up, and the fiscal picture is looking more worrying. And this comes against a backdrop in which interest rates were very low to start with. It seems like policymakers felt that they had to act now and act boldly to get ahead of the curve.
Q: Presumably the Copom is nervous because of what headline inflation readings are saying?
A: Those have been grim – and they’re going to get worse in the coming months. But the underlying drivers of current price pressures are transitory. Petrol inflation, for example, may rise to more than 30% in the second quarter on last year – but that’s because energy prices cratered this time last year. In fact, we’re telling clients to expect headline inflation below the central bank’s target next year.
Q: So how does that feed into your view about the length and intensity of this tightening cycle??
A: The Copom has given a pretty clear steer that this will be a front-loaded tightening cycle. And if we’re right that inflation will fall back sharply late this year and into 2022, we find it hard to see them raising rates at that point. That might shift their focus back to the economy – Brazil’s COVID-19 outbreak is getting worse, lockdowns are tightening and growth prospects are darkening by the day.
Q: You’ve written extensively on Brazil’s fiscal situation, and it’s notable that the Copom also highlighted this in its statement. Even if inflationary pressures are short-term, to what extent does the fragility of public finances argue for much higher rates? ?
A: There’s no question that this has the Copom worried – and as we move towards next year’s election, we may see increased pressure for a further loosening of fiscal policy. For the time being, these worries are pushing the Copom to hike rates. But higher rates also mean higher debt financing costs. We see concerns among policymakers about these costs creeping in as this new tightening cycle progresses.
Published 30th March, 2021