How far will the BC raise interest rates? Market awaits answers this Wednesday

It is a consensus among economists that the Copom (Monetary Policy Committee) of the Central Bank should announce, this Wednesday (4), a new hike of 1 percentage point in the basic interest rate (Selic), from 11.75% to 12.75% per year. However, predictability does not apply to expectations of the end of the monetary tightening cycle.

The median of the estimates of the Focus survey, which shows the estimates of analysts consulted by the BC, is a Selic at 13.25% per year in 2022. However, some already see a risk of the rate advancing above 14%, while those who are not linked to the financial market consider that the BC has already gone too far.

“The uncertainty [do mercado] is in relation to the communication from the Central Bank for June, if it will, in fact, close the door to changes in the Selic or if it will continue raising the interest rate”, says Lucas Vilela, economist at Credit Suisse in Brazil.

In March, BC President Roberto Campos Neto indicated his intention to end the cycle of high interest rates with the Selic at 12.75% per year. Later, he even said that the monetary authority would analyze the “surprise” in the IPCA (Ample National Consumer Price Index) that month to see if the route would change, but he did not comment again.

Based on the deterioration of the current and prospective inflation scenario, Mauricio Oreng, superintendent of macroeconomic research at Santander, sees the possibility of the BC changing its flight plan, making a residual adjustment of 0.50 point at the June meeting, in addition to the high this week. As a result, the Selic rate would rise to 13.25% per year at the end of the cycle.

“We believe that the Central Bank will end up revising upward the inflation projection in that most likely scenario, with oil at US$ 100, this particularly due to expectations, which have risen for 2022 and also for 2023”, he said.

The risk of discouraging expectations, in the face of inflation that can become inertial and new pressures with the lockdowns in China, requires an additional effort from the BC, in the view of Caio Megale, chief economist at XP Investimentos.

For him, the monetary authority will end the cycle of monetary tightening in June, with two consecutive increases of one percentage point in the interest rate, reaching 13.75%.​

“Inflation is close to its peak, but it is still a very high level. If the BC is not cautious, as it has been, it runs the risk that this higher inflation will be consolidated for a little longer,” he said.

“The fact that inflation is reaching a plateau does not necessarily mean that it can stop and let the adjustment already carried out take effect. economy.

With a higher inflation forecast (8.3% in 2022 and 4.6% in 2023), Credit Suisse predicts the Selic at 14% at the end of the cycle. In addition to the one percentage point increase in May, it also adds a 0.75 point increase in June and a 0.50 point adjustment in August.

Regarding the next steps, the Swiss bank expects the indication of a new increase in the Selic rate at the next meeting, on June 14th and 15th, without explaining its magnitude, leaving a degree of freedom on the decision.

“In a moment of very great uncertainty, the BC could value less clarity and evaluate the results throughout the meetings”, said the bank.

Gustavo Arruda, head of research for Latin America at BNP Paribas, considers that the Copom should be “a little less assertive” in relation to the next moves.

“If, on the one hand, the Central Bank has done a good job of analyzing the scenario, communication is where it can improve. This communication of things that we are not very sure about ends up hindering the coordination of expectations”, he said.

In the French bank’s projections, the BC will make further increases in the Selic rate in the coming months, given that the process of convergence of inflation to the target should take longer than expected. The expectation is for an increase of one percentage point in both May and June, and an increase of 0.5 point in August. Thus, the interest rate would end the cycle at 14.25%.

Despite the divergence in the Selic level at the end of the monetary tightening cycle, the need to continue raising the interest rate is consensual among analysts linked to the financial market. But in academia, economists believe that continuing to raise the Selic rate is not the best strategy to contain inflation in the current scenario.

Both Lauro Gonzalez, from FGV (Fundação Getulio Vargas), and José Luís Oreiro ​, from UnB (University of Brasília), cited the view of Christine Lagarde, president of the European Central Bank, about the little influence of the monetary policy instrument to contain an imported inflation.

“This interest increase will have no effect on inflation and will transfer income from the rest of society to the richest”, said Oreiro.

In the economist’s assessment, for the increase in the Selic to have the expected effect, it would be necessary to reach a level above 20%, which would produce a deep economic recession.

“The level of misery, unemployment, discouraged people is enormous, you can reduce inflation this way, but it will destroy the Brazilian economy in the process”, he said.

According to Oreiro, another mechanism that could help fight inflation is a strong appreciation of the exchange rate. In April, the dollar dropped to R$4.60, the lowest price in the last two years. But the trend was short-lived, and the American currency has already returned to operate above R$5.

For Gonzalez, the BC should wait for the effects of the interest rate hike, which went from 2% to 11.75% per year after nine consecutive increases, and reassess the situation during the second half of the year.

“In a scenario where the interest rate is already high, income is depressed, the job market is far below what is needed, with high unemployment, to what extent would all this not justify waiting to see if the demand components of inflation are playing a role that justifies a new interest rate increase,” he said.

Since the last Copom meeting, the consequences of Russia’s invasion of Ukraine, with shocks in energy and food prices, have intensified inflation worldwide. Driven by the mega-increase in fuel prices in Brazil, the IPCA rose 1.62% in March and reached 11.30% in the 12-month period.

In the double digits, inflation became even more widespread. Last week, the IBGE (Brazilian Institute of Geography and Statistics) reported that the IPCA-15 rose 1.73% in April – the biggest change for the month in 27 years – and reached 12.03% in the accumulated.

The fear of new restrictive measures in China due to the advance of Covid-19 and the potential impact on global production chains is also on the radar of analysts. With the worsening of the scenario, the median of market economists’ projections for the IPCA rose to 7.89% in 2022, according to the Focus survey released on Monday (2). For 2023, the estimate also increased to 4.10%.

Market expectations put inflation further and further away from the objective pursued by the BC, which is 3.50% for this year and 3.25% for the next, with a tolerance margin of 1.5 percentage points for more or less. . If the projections are confirmed, it will be the second consecutive overflow of the target, which is established by the CMN (National Monetary Council). In 2021, the IPCA totaled 10.06%, the highest since 2015.