BC warns of inflationary effect of PECs in ‘message minutes’

Proposals to reduce fuel taxation in the election year could have a negative effect on the exchange rate, leading to higher inflation and, consequently, the need for an even higher basic interest rate.

The assessment, which was practically a consensus in the market and in the Ministry of Economy, was made explicit this Tuesday (8) by the Central Bank.

In the minutes of the Copom (Monetary Policy Committee), a document in which it explains last week’s decision to raise interest rates to 10.75% per year, the institution does not mention the proposals that are being discussed in the government and in Congress, but states that “even fiscal policies that have downward effects on inflation in the short term can cause deterioration in risk premiums” and lead to “increase in inflation expectations and, consequently, an upward effect on prospective inflation”.

At a time when many analysts fear that President Jair Bolsonaro (PL) will take new measures to increase spending to seek re-election, the BC says that fiscal policies that imply an additional boost in demand could negatively impact prices of important assets —read- if, the dollar.

In Congress, there are at least two proposals to change the Constitution and allow a cut in fuel taxes. The measure has a high fiscal impact and its effect on consumer prices is uncertain.

The “Message Minutes”, as it was classified by some analysts, also brought a stronger message about Copom’s next steps. The institution indicated that it sees the need to raise interest rates beyond the 12% projected by the market from May and that the rate may take longer to fall – perhaps only in 2023.

The BC also signaled that there will still be at least two more interest rate hikes, even if in magnitude lower than last week’s 1.5 percentage point.

“The monetary tightening cycle should be more contractionary than the one used in the reference scenario”, said the Copom when citing the market forecasts for interest rates in the Focus survey, used as a reference in the BC’s inflation projections.

The BC also reinforced its concern with expectations for the IPCA (consumer price index). In recent weeks, inflation projections for 2022 and 2023 have been rising. For this year, a new goal burst is already foreseen. For the next one, the forecast is slightly above the core target of 3.50%.

For some economists, weaker activity and labor market data could change the Copom’s flight plan, as long as electoral issues and populist measures do not reverse the trend of appreciation of the real in recent weeks.

“The best comment in the minutes is the emphasis on fiscal measures and policies that could have a good short-term intention to reduce inflation, but which have a very high cost. This will bring more interest rates and more inflation down the road. very high fiscal cost for a measure of low return for society”, says Rafaela Vitoria, chief economist at Banco Inter.

She claims to disagree with the BC’s assessment and a large part of the market that it is necessary to raise interest rates to more than 12% to hold back inflation, as much of the Selic increase since March last year has not yet been felt in the real economy. .

“We are going to reach a Selic higher than necessary, and this may lead to the beginning of the discussion of interest rate drops sooner than the price curve. We will start to feel this impact of monetary policy in the next data, the labor market weak, negative industry, retail with difficulty.”

According to Caio Megale, chief economist at XP Investimentos, the stricter speech “puts an unequivocal upward bias for the terminal Selic rate”, projected by the institution, until then, at 11.75%. He also highlights the BC’s concern with fiscal impact measures to curb inflation.

“The Central Bank seems to recognize the potential negative impact of initiatives related to tax exemptions, such as those related to fuel prices that have been discussed in recent weeks,” said the chief economist at XP Investimentos.

Bank of America also recalculated its projections for upcoming meetings. The bank raised its expectation for the Selic until May this year to 12.25%, predicting a rise of 1 percentage point in March and 0.5 percentage point at the next meeting. The institution’s previous estimate was 11.25%. Itaú Unibanco revised its interest rate forecast to 12.50% per year.

Luis Otavio de Souza Leal, chief economist at Banco Alfa, says that, although the BC has indicated that interest rates will have to rise to more than 12%, he maintains the assessment that the institution may review the idea of ​​continuing the raising process. interest rates when it arrives at the May Copom meeting, due to weaker-than-expected first-quarter activity data.

“Obviously, the political issue can make our assumption not come true. As the BC made it clear, if the PEC on Fuels, or other measures with a lasting impact on fiscal policy and a temporary impact on inflation, prosper, we return to the scenario base indicated in the minutes”, he said.