Copom holds 1st meeting under Lula pressured by Planalto and inflation

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Pressured by a worsening in financial market expectations for inflation, the Central Bank is expected to maintain this Wednesday (1st) the basic interest rate (Selic) at 13.75% per annum at the Copom (Monetary Policy Committee) meeting. –the first since President Luiz Inácio Lula da Silva (PT) took office.

Despite the intense interest rate shock promoted by the Central Bank in an attempt to curb inflation, fiscal uncertainties and noise generated by the top echelon of the government –disturbed by the high level of interest rates– have contributed to the deterioration of price projections.

For Tony Volpon, former BC director, all attention will be focused on the monetary authority’s communication about the worsening in expectations. “The market expects this to be addressed in some way,” he says. “The big point of this Copom is what the BC will say about expectations for 2024, 2025. Everything up front has gone up a lot in these last few weeks in the [boletim] Focus.”

The Focus survey, which captures the perception of economists from the private sector, shows that the projection for the IPCA (National Index of Broad Consumer Prices) for this year jumped from 5.08% since the previous collegiate meeting, in December 2022 , to 5.74% in the data released last Monday (30).

This indicates that expectations for 2023 are already almost 1 percentage point above the inflation target ceiling. The central targets set by the CMN (National Monetary Council) are 3.25% in 2023 and 3% in 2024 and 2025, with a tolerance margin of plus or minus 1.5 percentage points.

For 2024, the most relevant period for the BC’s performance today, the expectation increased from 3.5% to 3.9% in four weeks – already above the central objective to be pursued. The worsening in the market’s perception was also reflected in longer-term projections, even in years that are not yet in the Copom’s sights.

The movement takes place in the wake of the prospect of an increase in administered prices with the possible reenactment of federal taxes on gasoline and ethanol as of March. According to Minister Fernando Haddad (Finance), “until the present moment” there is no new decision on the subject.

One of the first acts of the new Lula government was the submission of a provisional measure extending the exemption of federal taxes on fuels until the end of February.

“The most likely thing is that we have a retreat in inflation rates by the middle of the year and, in the period from July to September, inflation in 12 months should rise”, forecasts economist Heron do Carmo, professor at FEA-USP (Faculty of Economics and Administration at the University of São Paulo).

The increase will be felt compared to last year, when there were three consecutive months of deflation (from July to September). The fall in prices in that period was driven by tax cuts on fuel, electricity and other items.

The reduction in the tax burden took place in the midst of Jair Bolsonaro’s (PL) re-election plans, which were frustrated by his defeat by Lula at the polls.

Caio Megale, chief economist at XP Investimentos and former adviser at the Ministry of Economy, expects the Copom to talk about the importance of inflationary expectations in the BC’s next steps.

Given the worsening scenario, he projects that the monetary authority will keep the Selic at the current level of 13.75% throughout the year. “I find it difficult for the BC, which is looking at 2024, with market projections of inflation above [do centro da meta] and going up, manage to cut interest rates [neste ano]”, it says.

The economist saw the possibility of reducing the Selic rate in the short term with the approval of the PEC (proposed amendment to the Constitution) which authorized the expansion of expenses by R$ 145 billion in 2023, in addition to authorizing R$ 23 billion in investments outside the tax rule and other measures.

“The size of the PEC, for me, was very important in this definition because it determined the level of expenses much higher permanently and signaled the government’s predisposition to a more expansionist fiscal policy”, he says.

For Megale, the space for reducing the basic rate may appear next year if the fiscal situation proves to be more balanced with the design of the rule that will replace the spending ceiling – a mechanism that limits the growth of public expenses to the inflation registered in the previous year and is expected to be replaced.

So far, there is high uncertainty about the new fiscal framework – the proposal should be presented by April, according to the government’s forecast. “This milestone, if well done, is what will make room for interest rate cuts in 2024”, he projects.

In the opinion of Sergio Werlang, former director of Economic Policy at the BC and adviser to the presidency of the FGV (Fundação Getulio Vargas), the monetary authority should continue insisting on the fiscal issue.

“It is the BC’s role to say: ‘if you keep stimulating demand, complicating my life, I will have to maintain this rate for longer’. It is the message that it has to convey”, he says.

He also points out that the postponement of the interest rate cut is already on the economists’ account again. “The vast majority thought that by the middle of the year there would already be cuts, now I can see [essa expectativa ser recalibrada para] the third or fourth trimester. With all this spending pressure, the BC will have more demand pressure, this will increase inflation, it will force it to keep interest rates higher for a longer time”, he says.


Glossary

Basic interest rate

The Selic rate is the reference for other interest rates in the economy. This is the average rate charged in negotiations with securities issued by the National Treasury, registered daily at Selic (Special System for Settlement and Custody).

real interest rate

It considers a nominal rate, the Selic, for example, discounting inflation

ex ante real rate

Calculated looking forward (expected rate), based on projections for interest and inflation. It is the most relevant for monetary policy, as it influences future investment and consumption decisions

ex-post real rate

Calculated looking backwards (verified rate), based on interest and inflation over the last 12 months, for example. Serves to evaluate an investment already made

Neutral rate or structural interest rate

The one that keeps inflation on target and GDP growth equal to its potential. It can only be obtained from estimates.

Effective real interest rate

Difference between the real rate and the neutral rate. When the effective real interest rate is positive (real rate above the neutral one), the monetary policy is contractionary: it contains economic activity and contributes to the reduction of inflation. If it is negative (real rate below the neutral rate), it boosts economic activity and contributes to rising inflation

Copom (Monetary Policy Committee)

Body of the Central Bank, formed by its president and directors, which defines, every 45 days, the basic interest rate of the economy, the Selic

IPCA

Indicator measured by the IBGE that serves as an inflation target. The goal is defined by the National Monetary Council, a body that includes the BC, the Minister of Finance or Economy and other members of the economic team. The target for 2023 is 3.25%, with a limit of 4.75%. For 2024 and 2025, the expected target is 3%, with a limit of 4.5%

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