BC must assess the cost and benefit of exaggerating interest rates, economists say

Economists heard by leaf they claim that the Central Bank’s Copom (Monetary Policy Committee) should assess the costs and benefits of risking an exaggerated increase in the basic interest rate (Selic), especially with the already very depressed economic activity.

The dilemma is that, if the BC accelerates the pace of monetary tightening and raises the Selic above the 1.5 percentage point indicated in the previous meeting (with maintenance of the dose in the following decisions), it may have to start cutting more and ahead of schedule , making sudden movements that would generate volatility.

On the other hand, keeping pace may indicate that the autarchy is not as committed to fighting inflation, which should further raise projections for the coming years, generating the so-called unanchored expectations.

Exaggerated interest rate hikes are known as an overkill in economists’ jargon. The assessment is that with a dose greater than that necessary in the Selic, in the following years there will be a strong deceleration of inflation, with the threat of closing below the target’s floor, which should also be fought by the BC.

It is practically a consensus in the market that the BC should take the base rate to 9.25% per year this Wednesday (8) after speeches by the president and directors at recent events, but economists differ on what the BC should do in face of the escalation of prices.

BC president Roberto Campos Neto stated at an event at the end of November that the BC’s objective is to properly calibrate the rate of interest rate hikes so that the tightening is not greater or less than necessary.

“In all central banks there are two mistakes that can be made. The first is to go up too fast [os juros] and not having the perception of what the delay is [de efeito da política monetária], and not being able to measure it especially because, because of the pandemic, the models don’t work as well. You look later and draw that conclusion. The other is not doing enough and starting to un-anchor expectations. [de inflação]”, he said.

In the relevant horizon — for when the BC understands that the monetary policy takes effect — inflation expectations have been growing. For 2022 and 2023, estimates are at 5.02% and 3.50%, respectively, both above the target center for the periods of 3.5% and 3.25%. For next year, the number is already above the maximum allowed in the tolerance range, which is 5%.

After the latest events and public speeches by the BC president and directors, the chief economist of Ativa Investimentos, Étore Sanchez, revised the Selic hike projection from 2 points to 1.5, as indicated by the monetary authority at the Copom meeting in October.

The analyst, however, says that the Copom should be tougher and accelerate the pace of the Selic hike to bring inflation to the target in the relevant horizon.

“According to recent communications, the BC should opt for gradualism [de elevação da Selic], which does not generate bumps in the economy, keeping the pace of increase. If you go up a lot now, you may have to cut ahead of schedule. It also minimizes the risk of overkill,” he explains.

Sanchez considers that it is necessary to evaluate the cost and benefit of each action. In his view, accelerating the pace of monetary tightening has the advantage of anchoring inflation expectations, even if the BC has to make significant cuts in interest rates ahead of schedule.

“Unanchoring expectations leads to loss of credibility and, which is much more harmful than recessive developments [da atividade]”, evaluates.

There is also a discussion about a possible shift of the relevant horizon. In this hypothesis, BC would give more importance to 2023, signaling abandonment of the 2022 target, which would justify not accelerating the pace of increase.

The thesis supports Cristiano Oliveira’s bet, chief economist at Fibra bank, that the BC should increase the Selic by 1.5 point on Wednesday.

“The official communication from the Copom members after the release of the October minutes seems to indicate that the committee will soon choose to adjust the monetary policy horizon, giving more explicit weight to calendar year 2023. In our opinion, this strongly reduces the probability of intensifying the pace of the Selic hike, as it was priced by the interest rate curve recently,” he says.

“With the Selic going to 9.25%, we are still far from overkill. On the other hand, the market came to price extremely high rates a few weeks ago for the end of 2022 which, if confirmed, could be configured, in my opinion, as an overkill”, emphasizes Oliveira.

The partner at Fatorial Investimentos Jansen Costa claims that the increase of 1.5 points is enough. “Many believe it’s behind the curve [abaixo do necessário], but I think that decision would be in line yes. We had important fiscal space and we are now going to suffer from the first half-year retraction in the economy,” he points out.

“The BC has to pursue inflation within the target. This is the Central Bank’s objective, so it will raise interest rates because of this. What can happen is to exaggerate the rise as it exaggerated the fall because what matters is the target of inflation,” continues Costa.

The chief strategist at MAG Investimentos, Patrícia Pereira, projects an increase between 1.75 points and 2 points at this meeting, keeping the focus on the 2022 target.

“It would be very harmful in terms of credibility to abandon 2022, so I think the BC should step up to try to anchor expectations again. In this scenario, we will probably have an overkill, but with more benefits compared to doing it gradually and unanchoring.” , it says.

In her analysis, she considers that cutting interest rates more sharply in the future is less harmful than leaving inflation at a higher level.

The specialist points out that the mismatch between what the market thinks the BC should do and what it is actually going to do has grown. “This is an indication of loss of credibility,” he says.

João Beck, an economist at the BRA manager, points out that it will also be a challenge to define how long the Selic should remain at a high level, above neutral, which slows down the economy.

“How long we need this Selic at such a restrictive level is still unknown. On the one hand, you have recent good data that may prove more permanent. On the other, we are entering an election year that could result in a detracting debate for the economic conditions hindering the BC’s work”, he reinforces.