Rate of interest rate cuts generates expectations in Copom – 03/17/2024 – Market

In a scenario in which a new reduction of 0.5 percentage points in the basic interest rate (Selic), to 10.75% per year, is considered practically certain next Wednesday (20), economists’ attention is turn to the future steps of the Copom (Monetary Policy Committee) and a potential change in its communication about the pace of cuts ahead.

The discussion gains ground as the Central Bank board advances in the interest rate easing cycle. Since August last year, there have been five consecutive cuts of the same intensity. On each occasion, the Copom indicated that it would repeat the dose “in the next meetings”, which means that the rate of reduction would be maintained at least in the following two meetings.

“Confirming the expected scenario, the Committee members unanimously foresee a reduction of the same magnitude in the next meetings […]”, says a statement from the last Copom meeting.

A possible inflection of the plural into the singular in three of the almost 800 words that make up the text has been generating debate in the financial market on the eve of the next Copom meeting. This is because this section carries a clue about the potential size of the interest rate drop cycle this year.

If there is no change, the BC signals that it should, at least until June, maintain the pace of Selic cuts adopted so far. If the guidance is implemented, the basic rate would return to single-digit levels in the middle of the year, reaching 9.75% per year. Interest rates have been in double digits since February 2022.

On the other hand, a possible change in communication would give a greater degree of freedom to Copom’s actions in an environment marked by uncertainty in the global scenario and doubts regarding the trajectory of services inflation.

At the same time, the lack of predictability regarding the Selic at the end of the current cycle of falling interest rates could generate greater volatility in asset prices – which would open up space for the BC board to be more conservative.

The topic of “forward guidance” (future guidance, in the market’s technical language) was also debated by some members of the BC’s top leadership. At the beginning of the month, the director of Monetary Policy, Gabriel Galípolo, highlighted that the data that serves as input for the committee’s decision every 45 days is above any prescription.

“We adopted cuts of 50 basis points [0,5 ponto percentual] precisely to have the advantage of gaining time and seeing how things are happening”, he stated.

The public speeches by BC directors about the pros and cons of a possible change in guidance indicate that the matter will at least be brought to the table at next Wednesday’s Copom meeting, in the opinion of Santander Asset’s chief economist, Eduardo Jar.

“I see a considerable chance of changing the plural to singular. But, if the statement only changes [o trecho] ‘in the next meetings’ to ‘in the next meeting’, this does not lead to a change of vision of the scenario. He [Copom] it can go by droppers”, he states.

Jarra, however, says there is no urgency for this change. For the economist, the BC board will continue with interest cuts of 0.5 percentage points until the end of the first semester, reducing the intensity until the Selic reaches 8.5% at the end of the cycle.

Its projection is below the financial market median. According to the latest edition of the Focus bulletin, agents expect the basic interest rate to close 2024 at 9% per year.

Within this group of institutions is XP, which sees in the composition of the scenario a lower probability of the Fed (Federal Reserve, central bank of the USA) cutting interest rates in the short term, signs of a labor market still very heated, and indications from the government of Luiz Inácio Lula da Silva (PT) of parafiscal expansion measures – such as greater release of credit by public banks, for example.

As for communication, XP’s chief economist, Caio Megale, who is a former advisor at the Ministry of Economy, considers that there has not been a sufficient increase in uncertainty for the committee to change its orientation.

For him, the discussion about “forward guidance” is valid given the greater risk for inflation convergence towards the 2025 target – 3%, with a tolerance range of 1.5 percentage points more or less. However, it rules out changes at the next meeting due to the still high Selic level.

“If it keeps the plural, it means that it [Copom] have in mind to arrive [com a Selic] by at least 9.75% [ao ano]. Nobody today thinks that the Selic has to be 9.75% or more”, he says.

Megale sees a chance for the committee to explain in the statement that the guidance is an indication of the most likely scenario, not a formal commitment from the Copom, as per the warning given by the BC’s director of Economic Policy, Diogo Guillen, so that the market does not confuse “guidance” with determination of interest.

In the economist’s opinion, from the moment the Selic returns to single digits, it will be time for the BC board to make a fine adjustment.

Luis Otávio Leal, chief economist at G5 Partners, understands the recent statements by Galípolo and Guillen as a way for the BC to prepare the ground for the removal of the plural in future guidance. “It’s not the end of the world. It won’t change the Central Bank’s monetary policy. It will simply gain degrees of freedom,” he says.

He projects that the Copom will slow down the pace of cuts from June onwards, continuing with reductions of 0.25 percentage points until closing the year with the Selic at 9%.

“From the moment there is a risk of having to reduce the pace [de cortes da Selic]he [Copom] Maintaining the forward guidance would be counterproductive, because, when you don’t comply with the forward guidance, you lose credibility”, he says.

Regarding the disinflation process, Leal is cautious. On the one hand, she sees a scenario of greater global uncertainty in the second half of the year with the possibility of Donald Trump being elected again in the USA. On the other hand, it places food inflation as an upward risk given the impact of climate effects on ‘in natura’ food.

The food and beverage group continued to be highlighted in the IPCA (Broad National Consumer Price Index) in February. In the last 12 months, official inflation in Brazil reached 4.5% – the ceiling of the target pursued by the BC.

Heron do Carmo, professor at FEA-USP (Faculty of Economics, Administration, Accounting and Actuary, University of São Paulo), says he is not as calm about the country’s inflationary scenario as he was at the end of 2023. “We are not with a lot of room for reducing inflation”, he says.

The expert expects inflation to fall until May and then be subject to pressure from the food, fuel and services groups. “Everything indicates that we will have food pressure [sobre a inflação]because we are going to go from a situation of a super harvest to a smaller harvest”, he states.

“If we have a serious problem with food or fuel, this could cause inflation to remain very close to the target ceiling, a little below, until the middle of the year, and then start to exceed the ceiling”, he projects.

Tatiana Pinheiro, chief economist for Brazil at Galapagos Capital, shows a little more optimism. The most recent IPCA data, according to her, shows the “services” component to be well behaved, reinforcing economists’ expectations for the Selic’s trajectory. At the end of the cycle, the economist projects that the basic interest rate will reach 8%.

Looking at the real interest rate, she considers that the Copom has a “relatively comfortable” space to continue easing interest rates.

“In this space of comfort, it makes sense for the Central Bank to prioritize forward guidance to reduce volatility [nos preços dos ativos]”, he says. “This guidance should still make sense for a few more meetings.”