Copom should keep interest rates at 13.75% and send a message to Lula about fiscal risk, say analysts

The Central Bank is expected to maintain the basic interest rate at 13.75% per annum at this Wednesday’s (7th) Copom (Monetary Policy Committee) meeting, but the monetary authority is expected to send messages to Luiz’s elected government. Inácio Lula Silva (PT) in relation to the risks of fiscal policy for inflation.

The discussions around the PEC (proposed amendment to the Constitution) of the Transition, approved by the CCJ (Constitution and Justice Commission) of the Senate this Tuesday with a fiscal impact of R$ 168 billion in expenses above the spending ceiling, already lead economists to assess that the BC will take longer to cut interest rates in 2023.

The rate may even rise in a more extreme scenario, if inflation also takes longer to fall.

In the Focus bulletin, with market projections collected by the BC, the expectation of the beginning of the fall in interest rates moved from June to August of next year. As a result, the median estimate for the Selic rate at the end of 2023, which was 11.25% at the previous meeting, dropped to 11.75%. For some analysts, a scenario of high interest rates cannot be ruled out for any longer.

The BC must also evaluate the data that show a recovery of GDP (Gross Domestic Product) and employment faster than previously expected and the effects of this on inflation, which may exceed the ceiling of the target in 2023 for the third year in a row.

Alberto Ramos, director of the macroeconomic research group for Latin America at Goldman Sachs, expects a “fine calibration” of the language, so that the Central Bank makes an alert, without generating alarm.

“Central Bank does not have to react to a hypothetical thing, but the Central Bank has to react to the repricing that this risk generated”, he said.

Among the impacts of fiscal uncertainty, Ramos cites that inflation expectations for next year have risen, the exchange rate has come under pressure and has become a little more volatile, and that long-term interest rates have risen.

For him, the BC’s strategy could be significantly affected if the new government embarks on a “fiscal populism tune”, including the use of public banks to release credit, in addition to extract expenses.

In this scenario, it would be necessary to raise interest rates again, a probability that the economist sees as relatively low. “If we had interest at 8%, 9%, I would say that this risk is significant, but with Selic at 13.75%, real interest rate at 8%, let’s face it, it is already quite salty”, he said.

Marco Maciel, partner and economist at Kairós Capital, says that a PEC that keeps Bolsa Família within the spending ceiling, even with about R$ 200 billion more, as was filed by the PT in Congress, is less discouraging news than than the end of the fiscal rule and the total lack of control of public accounts.

Even so, it is a scenario that is unlikely to allow the Central Bank to cut the basic interest rate next year.

“It’s the ‘hawkish’ tone [duro] that the communiqué has to have, trying to show that the Selic will stay at 13.75% for practically the whole of next year”, says Maciel.

“The reversal of the fiscal scenario could change that. Now, the more noise that is generated, the less likely the Selic rate will fall. I don’t think this type of fiscal signal they are giving is enough to appease the market’s doubts.”

Andrea Damico, partner and chief economist at Armor Capital, says that BRL 150 billion or BRL 200 billion more in spending will generate a significant growth in the debt next year and that the BC should reinforce the message about the need to fiscal responsibility and an anchor that guarantees debt stabilization later on.

Without that, she also does not rule out that interest rates remain at the current level until the end of 2023.

“The BC should alert to the risks that a fiscal policy that is not perceived as responsible can cause for inflation, for monetary policy and, consequently, for growth”, says Damico.

“Today, the risk we run the most is this, not having a credible fiscal policy and the government not being perceived as fiscally responsible. And the indications are not good.”

The two claim that it is important for the new government to show signs that the increases in spending in 2023 will be offset by cuts in some expenses and even increased revenues.

Maurício Oreng, superintendent of macroeconomic research at Santander, says that the Central Bank can express its concerns with the fiscal uncertainties in the balance of risks for inflation, currently considered symmetrical by the monetary authority.

“I have been arguing for some time that there is a bullish asymmetry [para cima] in the balance of risks, perhaps the BC wants to increase the tone of fiscal risks a little in line with what was done in recent communications from the entire board”, he says.

BC president Roberto Campos Neto even said at an event with economists that the direction of public accounts from 2023 onwards will be essential to understand how monetary policy will work next year.

Other topics that should be at the center of the debate at the next Copom, according to the Santander economist, are the slowdown in economic activity and the level of the output gap – which measures the difference between potential and actual growth in the economy.

“It is important to keep in mind that fiscal expansion at the moment when the hiatus is closed is even more inflationary”, he points out.