BC raises Selic by 1.5 points and interest rates return to double digits after almost 5 years

The Central Bank’s Copom (Monetary Policy Committee) raised the basic interest rate from 9.25% to 10.75% per year this Wednesday (2). Since July 2017, the Selic rate has been below double digits, a period in which it was reduced in the face of falling inflation and virtually stagnant economic activity.

The BC also signaled that the tightening cycle started in March last year has not come to an end, in the face of still resistant inflation that threatens to burst the target for the second year in a row.

But it said in its statement that, in terms of its next steps, the committee sees a reduction in the pace of adjustment of the basic interest rate at its next meeting as more appropriate at this time.

According to Copom, this signal reflects the fact that the cumulative effects of the monetary tightening cycle will still manifest themselves over the next few months.

At the previous meeting, in December, the BC also raised the rate by 1.5 percentage points and indicated that it would make a new high of the same magnitude at the beginning of the year. Therefore, all analysts consulted by Bloomberg already expected this increase. The committee meets again now on March 15th and 16th.

As shown by leaf, the cycle of interest rate increases in Brazil —eight rises in a row, totaling 8.75 percentage points— is the longest among the world’s major economies. In March of last year, the basic rate was 2% per year, the lowest level since the creation of the Copom, in 1996.

The Selic is now at the highest level since May 2017, still under Michel Temer (MDB), when interest rates were 11.25% per year.

This is also the biggest tightening cycle since the creation of the inflation targeting system, when the basic rate rose from 25% to 45% per year, in March 1999, due to the end of the fixed exchange rate regime.

The increase of 8.75 percentage points since last year also surpasses the increase of 8.50 points seen from October 2002 to May 2003, in the transition between the FHC and Lula administrations.

According to this week’s Focus report, in which the BC releases market projections, economists expect interest rates to close 2022 at 11.75% per year. By 2023, it would drop to 8% per year.

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

“The Copom emphasizes that the future steps of monetary policy may be adjusted to ensure the convergence of inflation to its targets, and will depend on the evolution of economic activity, the balance of risks and inflation projections and expectations for the relevant horizon of monetary policy. “, the committee said in its statement on Wednesday.

The Copom considers that, given the increase in its projections and the risk of unanchoring inflation expectations for the coming years, it is appropriate for the monetary tightening cycle to advance significantly in contractionary territory.

“The Committee emphasizes that it will persevere in its strategy until it consolidates not only the disinflation process but also the anchoring of expectations around its goals.”

According to the BC, a possible reversal, even if partial, of the increase in international commodity prices in local currency would produce an inflation trajectory below the reference scenario. On the other hand, says the institution, fiscal policies that imply an additional boost in demand or worsen the future fiscal trajectory can negatively impact prices and the country’s risk premium.

For the institution, despite the more positive performance of public accounts in 2021, uncertainty regarding the fiscal framework continues to maintain a high risk of de-anchoring inflation expectations.

Brazil ended 2021 with the fourth highest inflation among 44 economies highlighted by the OECD and should end 2022 among the nine highest consumer rates, according to projections and data collected by the institution that brings together the most relevant economies on the planet.

In addition, the IPCA (consumer price index) should exceed the inflation target for the second year in a row. Market projections collected in the Focus survey are for a rate of 5.38% in 2022, with the target being 3.50%, with a tolerance limit of up to 5%. Last year, inflation was 10.06%, to a cap of 5.25%.

The projections released by the BC this Wednesday are 5.4% for 2022 and 3.2% for 2023.

In its assessment of the current scenario, the Copom stated that in the external scenario, the environment remains less favorable, as greater inflationary persistence increases the risk of a faster monetary tightening in the US, making financial conditions more challenging for emerging economies.

In addition, the new wave of covid-19 adds uncertainty about the pace of activity, while at the same time it could delay the normalization of global production chains, according to the committee.

In relation to the Brazilian economy, he says that indicators related to the fourth quarter had a slightly better evolution than expected, in particular those related to the labor market. Consumer inflation, on the other hand, continued to surprise negatively and several measures are above the range compatible with meeting the target.

In an open letter released last month to explain the failure to meet the target, BC President Roberto Campos Neto attributed the result to successive cost shocks, such as rising commodity prices along with the depreciation of the real, a flag of water scarcity. in electricity and an imbalance between demand and supply of inputs, in addition to bottlenecks in global production chains generated by the pandemic.

Rafael Ihara, chief economist at Meraki Capital, says that the reduction in the pace of interest rate hikes starting in March is in line with market expectations. He projects an increase of another 1 percentage point, to 11.75%, next month, and an increase of another 0.50 point, to 12.25%, in May, ending the cycle of high interest rates.

“A lower high was already priced in at the March meeting. The question was whether he [Copom] it would be explicit or not. He preferred to make the reduction of pace very clearly at the next meeting,” he said.

Ihara says that, as of May, the BC will focus on 2023 inflation, given the lag between high interest rates and its strongest effects on the economy.

He recalls that the country has gone from a real interest rate (discounting the inflation projection for 12 months) of around -1% to almost 7% per year and that much of the impact of this tightening will still be felt in 2022.

For him, the timing of the start of the interest rate fall cycle will now depend on the electoral issue, which may postpone the first cut to 2023.

Carlos Kawall, director of ASA Investments and former Secretary of the Treasury, believes that the Central Bank surprised by signaling that it will reduce the rate of increase in the Selic rate at the next meeting. “We thought we would leave this open, due to the fact that, in March, it still has power over 2022 inflation. But it made a milder option, more ‘dove’, and anticipated that it will reduce the pace”, he said.

In the jargon used among economists, “dove” means that the monetary authority adopts a softer speech, with the intention of cutting or raising interest rates less.

Kawall points out that if the Central Bank is more lenient at the March meeting, with an increase of 1 point, it may have to make a new increase at the next meeting, by 0.50 point, depending on the evolution of inflation expectations for 2023.

“We are very close to the end of the cycle [do aperto monetário], which may take place at the March meeting, but, with the reduction of the pace, it may extend until the May meeting, with the Selic reaching 12%, 12.25%”, he said.

Luiz Fernando Figueiredo, founding partner of Mauá Capital and former director of monetary policy at the BC, believes that the tone used by Copom indicates that the autarchy is within its flight plan and, given the stage of monetary tightening, should increase the Selic at the rate of 1 percentage point at the next meeting.

“Although it is having a good fiscal performance, first year of primary surplus since 2013, this flirtation with the ceiling blowout, not having a reasonable fiscal anchor next year, this risk of the fiscal framework increases the risk of having an expectation unanchor” , analyzed.