In April 2013, the BCB began the most aggressive tightening cycles launched by any central bank that year, raising its benchmark policy rate (the Selic) to 10.00% from an historical low of 7.25%. After having hiked the Selic by 50 bp for five consecutive months, we believe that the BCB is about ready to taper the pace of hiking and expect it to deliver one final hike of 25 bp and thus ending its tightening cycle with the Selic at 10.25%.
The risk to our view is tilted to more tightening with two likely scenarios: either the BCB delivers two hikes of 25 bp before going on hold, or it decides to deliver one final hike of 50 bp. It’s fairly easy to justify a deeper and longer tightening cycle. In December, the IPCA inflation index surprised on the upside, reaching 5.9% y/y – considerably above the rather generous target of 4.5%. Also, the 12-month expected inflation ended 2013 at 6%, indicating to us that inflation expectations are less anchored than ever! The continued pressure on the Brazilian real poses an upside risk to the inflation outlook that also could prompt the BCB to react more strongly.
However, the minutes from the latest Copom meeting featured a less hawkish rhetoric. For instance, the BCB said that “the Committee considers that the transmission of the effects of monetary policy actions over inflation occurs with lags”. This indicates to us that the scope for more interest rate hikes remains limited. Also, one cannot completely disregard the political element of the interest rate decision …
It’s all about politics
2014 is an election year in Brazil. A return to double-digit interest rates is already widely considered as a political setback for President Dilma Rousseff, who made lower borrowing costs a key economic goal of her government during the 2010 election campaign. Extending the tightening cycle either by more rate hikes of 25 bp or by 50 bp could jeopardise economic growth and thus voters’ sentiment towards President Rousseff. This should obviously not be a concern for a dedicated inflation targeting central bank, but …
It is no secret that from time to time monetary policy in Brazil has been dictated by the government, and as a result the BCB’s credibility as an inflation fighter has suffered. For a prolonged period spanning H2 2011 to H2 2013 (illustrated by the grey area in the chart), the BCB’s interest rate decisions appeared to be less tightly linked to inflation and more to the business cycle. Today’s interest rate decision is, therefore, especially important. An interest rate hike of 50 bp will send a strong signal that the BCB is truly dedicated to fight inflation, and may win back some of its lost credibility in recent years. Nonetheless, we maintain our view that the BCB will go for a minor hike of only 25 bp.
Nordea