The Monetary Easing Cycle Intensifies

BRAZIL ECONOMICS - Report 16 Jan 2017 by Affonso Pastore, Cristina Pinotti and Marcelo Gazzano

At the last COPOM meeting, the Central Bank not only cut the SELIC rate by 75 basis points, it also indicated that until a contrary indication this will be the pace of cuts for the coming meetings. This dragged down the longer term interest rates. It was a correct decision in light of the steep drop of actual and expected inflation, both of which are converging to the 4.5% target, and because of the fragility of economic activity. The aggressive easing of the SELIC rate does not pose a risk to the convergence of inflation to the target, and although it does not change the scenario for only slow economic recovery in 2017, it should contribute to a slightly stronger rebound in the second half of the year and improve the perspectives for growth in 2018.
By initially adopting an extremely conservative attitude, the current Central Bank’s monetary policy committee team made it explicit that cooperation from the fiscal adjustment was necessary, and that the Bank would fight to rebuild the credibility of its commitment to the inflation target. With the approval of the constitutional amendment that freezes spending in real terms, the uncertainties from the fiscal side decreased, and the Bank’s insistence on the commitment to bring inflation to the 4.5% target in 2017 led to a sharp drop in the inflation expectations, which are now clearly converging to the target over all projection horizons from 2017 onward (Graph 1). Until the first quarter of 2016, the Focus survey showed the median of expectations above 4.5% over all horizons, but the combination of appreciation of nearly 15% in the exchange rate and the disinflationary force from the recession has now caused rapid convergence of inflation to the target.

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