BC indicates that Selic should be higher than expected by the market until 2023

The Central Bank’s Copom (Monetary Policy Committee) considers the current rate of interest rate hike adequate to bring inflation and expectations to the targets in 2022 and 2023, but assesses that the base rate should remain above projected by the market during the period.

Before the meeting, economists expected the benchmark interest rate (Selic) to advance to 11.75% throughout 2022 and then start a downward cycle, with 11.25% until December and 8% at the end of 2023, according to Focus research. This was the scenario used in the BC simulation.

With this, the monetary authority indicates that interest rates should be above 11.75% next year and 8% at the end of 2023.

The Focus survey is carried out by the monetary authority on a weekly basis. In it, the BC collects projections from economists from financial institutions and analysis houses for the main economic indicators, including inflation, GDP (Gross Domestic Product) and interest rates, for the next four years.

“The Copom assessed that, considering this bias due to the asymmetry of risks, its projections are above the target for both 2022 and 2023. Given this result, the Copom concluded that the monetary tightening cycle should be more contractionary [juros mais altos] than the one used in the basic scenario throughout the relevant horizon”, highlighted the minutes of the last meeting released on Tuesday (14).

In the relevant horizon — for when the BC understands that the monetary policy takes effect — inflation expectations have been growing. For 2022 and 2023, the projections are at 5.02% and 3.46%, 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%.

“As for the balance of risks, the Committee considered that the risk of unanchoring expectations for longer terms, derived from the developments in the fiscal scenario, indicates that there is an upward bias in the projections of its basic scenario”, the minutes said.

Last week, the Copom raised the base rate again by 1.5 percentage points, to 9.25% per year. In the statement, the BC indicated a new high of the same magnitude for its next meeting, in February, to 10.75% per year.

The current cycle of hikes in the basic rate is the most aggressive since 2002, with sudden increases, and it is the one that will have the greatest difference between the initial and the final rate since the creation of the inflation targeting system, in 1999.

The interest rate shock is a response by the BC to the price hike observed since the end of last year and to successive upward revisions of inflation expectations for next year.

Despite not having accelerated the pace of the Selic hike, the BC raised the tone regarding the monetary tightening in the last decision. The Copom admitted for the first time that expectations are discouraging and indicated that it will continue to raise interest rates not only until inflation slows down, but also that market projections for the coming years are around the target.

Accelerating the pace would be to raise interest rates above 1.5 percentage points per meeting.

The municipality reinforced in the statement that the Selic must reach a “significantly contractionary” level. That is, well above neutral interest (which neither heats up nor contracts the economy).

This week, after BC’s harsher tone in the statement, the market raised the projection for the Selic in 2022 to 11.50% and kept 8% for 2023.

BC’s projections for inflation are 10.2% for 2021, 4.7% for 2022 and 3.2% for 2023. The analysis was made with the interest rate of the Focus survey, in which market expectations are disclosed, and exchange rate starting at R$5.65.

“In this scenario, projections for regulated price inflation are 16.7% for 2021, 3.8% for 2022 and 5.2% for 2023. The ‘water scarcity’ tariff flag is adopted in December 2021 and hypothesis of ‘red level 2’ tariff flag in December 2022 and December 2023”, stated the text, in relation to measures that impact the energy bill to mitigate the effects of the water crisis.

The Copom assessed the appropriate pace of interest rate hikes with alternative scenarios.

“The committee also compared scenarios involving adjustment rates greater than 1.50 percentage points with scenarios in which the interest rate remains high for a longer period than implied in the basic scenario”, highlighted the minutes.

“Based on these results, Copom members debated the most appropriate strategy. It was concluded that the pace of adjustment of 1.50 percentage points, at this time, is adequate to reach, throughout the monetary tightening cycle, a sufficient level not only to ensure the convergence of inflation over the relevant horizon, but also to consolidate the anchoring of longer-term expectations,” he continued.

In the text, the BC justifies that in its basic scenario (with interest from the Focus survey and exchange rates starting at R$ 5.65), inflation projections are above the target for 2022 and around the target for 2023.

Regarding the evolution of prices, the BC detailed in the minutes that consumer inflation remains high, with a widespread increase among various components, and has been more persistent than anticipated.

“The rise in the prices of industrial goods has not yet cooled down and should persist in the short term, while inflation in services accelerated, reflecting the gradual normalization of activity in the sector, a dynamic that was already expected,” the text said.

“Recent readings came in above expectations and the surprise occurred in both the more volatile components and those most associated with underlying inflation. Prospectively, the significant drop in international energy commodity prices, which have shown substantial volatility, limited the upward revision of projections short term”, he pointed out.

Regarding economic activity, Copom members argued that the GDP for the third quarter had an evolution “slightly lower than expected, despite the activities most affected by the pandemic continued on a trajectory of robust recovery”.

“Higher frequency indicators point to a decline in economic activity, spread across several sectors, in September and possibly in October. In the same sense, the confidence indices already available for the initial months of the current quarter show deterioration.”

With this, the BC revised downwards its expectations for the performance of the economy in the short term, which were at 4.7% for 2021 and 2.1% for 2022. The new projection should be released this Thursday (16).

“For 2022, if on the one hand the rise in risk premiums and the more intense tightening of financial conditions act by discouraging economic activity, on the other hand, the Copom assesses that growth tends to benefit from the performance of agriculture and the remaining process of normalization of the economy –​particularly in the services sector and in the labor market– as the sanitary crisis cools down”, evaluated the minutes.