BC tightens interest rates while government signals fiscal loss

The deterioration of the economic scenario throughout this year led to a worsening in expectations of the main indicators for 2022. In September, Brazil surpassed the double-digit barrier on inflation and should also reach the mark in the basic interest rate (Selic) in February.

There is also a risk of falling GDP (Gross Domestic Product), leading the country into recession, all at the same time.

The BC (Central Bank), in the assessment of economists, has weighed its hand in raising interest rates to contain the price hike in view of the government’s signs of abandoning the fiscal anchor.

This strategy, they claim, further depresses activity and has a limited effect on inflation, which began as a cost shock —for which monetary policy is not as effective— and has spread.

The noise surrounding a possible change in the fiscal regime, with maneuvers to open space in the spending ceiling, raised the so-called risk premium to the interest rate curve, an added cost to cover possible impacts, and affected expectations for inflation.

The movement impacts prices mainly through the devaluation of the Brazilian currency against the dollar.

The government’s main intention was to create a source of funds to fund the Auxílio Brasil, a social program that replaced Bolsa Família.

“The big problem is not the aid, it is necessary. The issue is to carry out this type of program without talking about reorganizing expenses. People are in a vulnerable situation, with an increase in extreme poverty. It is difficult for the government to ignore this, regardless of whether it is an electoral period or not”, says the chief strategist at MAG Investimentos, Patrícia Pereira.

For the economist, in this sense, the BC is alone in trying to reverse inflationary pressure.

“The inspector could help by signaling some concern about spending. The loss of credibility of the spending ceiling also weighs heavily, because it leaves room for doubt whether it will be circumvented again,” stated Pereira.

BC president Roberto Campos Neto has repeated that the country is paying a high price for a fiscal deviation that was not so great.

For him, the country had a relevant improvement in terms of expectations for the public debt and the primary result, but economic agents look ahead and are concerned about the sustainability of public accounts in a scenario of low growth and high interest rates, which explains the worsening in the projections.

In the presentation of the inflation report on December 16, when asked if the BC saw itself isolated in the fight against inflation, Campos Neto said that the important thing in the monetary authority’s decision-making is to understand how economic agents see the scenario and how this influences the macroeconomic variables.

“It’s not about [o BC] being alone or not, there is obviously a need for programs to fight the pandemic and there is a need to balance expenditures with the sources of funds,” stated Campos Neto.

“What we’ve noticed in recent months is that there was a questioning regarding the validity of the framework [fiscal] that until then existed and that caused the risk premiums to rise. In the short term, we had positive surprises and part of this spreads over the next few years, but we understand that there was this questioning,” he said.

The chief economist at Credit Suisse Brasil and columnist at leaf Solange Srour says that the BC must face a great challenge next year and that the loss of credibility of the spending ceiling contributed to the worsening of the scenario.

“I don’t agree that the deviation was small. [déficit] primary better than expected, but it’s a photo of the moment. The market looks ahead to the movie. Once a rule is broken, we can assume that it can be broken again, which creates uncertainty, especially in an election year,” says Srour.

“The challenge is to try to control inflation expectations when there is a clear deterioration in the fiscal framework. It is not possible to minimize what happened to the ceiling. It is not just the fact that we will have an increase of R$100 billion [nas despesas], which in itself would be bad, but breaking the rule, which theoretically would be a limit for opportunistic behavior by the government, was not”, says consultant and former director of BC Alexandre Schwartsman.

This year, inflation will exceed the target set by the CMN (National Monetary Council) at 3.75% — with 1.5 percentage points of tolerance for up and down. Thus, the indicator could not exceed 5.25%.

The BC projects 10.2% increase in prices in the period, almost double the established maximum.

Under the cost of very weak activity and high interest rates, for 2022, the monetary authority expects inflation to fall by half, to 4.7%, but still close to the target ceiling, which is 5% (center of 3.5%).

According to the latest Focus bulletin, in which the BC releases market projections, economists consulted already forecast a ceiling overflow in 2022, with 5.03%.

In the inflation report, the BC cut in half its expectation for next year’s GDP and now expects growth of 1%. In September, the autarchy saw an increase of 2.1%.

BC’s estimate is above market projections. With the scenario deteriorating, financial institutions and analysis houses expect a 0.5% increase in GDP for 2022, according to last week’s Focus report. A month ago, the expectation was 0.70%. But there are already institutions estimating a drop in GDP in 2022.

In the last decision, on December 8, the BC’s Copom (Monetary Policy Committee) 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.

High inflation with weak economic performance is what economists call stagflation, a scenario that is projected for the next year.

Normally, weak economic performance leads to lower inflation, just as high interest rates presuppose anchoring of expectations. The factors, however, depend on a well-established fiscal and monetary policy.

For economists, however, it was not only the worsening of the fiscal situation that led to the unanchoring of inflation expectations (when market projections for the following years are above the target). There was, they say, an error in the BC’s conduct, which took the Selic to the lowest level in history, at 2% per year, in August of last year and maintained the level until March of this year.

The assessment is that the monetary authority took a long time to notice the persistence of inflation.

“The BC arrived late, but I would have arrived late. I even had a more optimistic view, I thought the price shock was transitory. The Copom started to raise interest rates earlier than I considered adequate and made a mistake, but I would have made more mistakes” , says Schwartsman.

Srour agrees that there was an error, but considers that the decision was supported by a large part of the market.

“Maybe it was a communication or diagnostic error, that inflation would be temporary. At that time, it was better to have adopted a speech with less guidance [sinalização dos passos futuros] because the uncertainty was too great,” he says.

To try to regain credibility and curb market forecasts, the BC raised the tone in relation to monetary tightening in the latest 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.