The Start of the Monetary Easing Cycle

BRAZIL ECONOMICS - Report 07 Aug 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

Why did the COPOM decide to cut the SELIC rate by 0.5 percentage point, with five favorable votes against four votes for a decrease of only 0.25 p.p.? An initial interpretation is that the Central Bank yielded to political pressure from the government, which was indeed strong, and hence not only has lost a measure of its independence both in relation to the government and the market, as shown by the yield curve indicating a cut with magnitude of 0.5 p.p.

Another interpretation is of an agreement between Campos Neto and Fernando Haddad conditioning the reduction of 0.5 p.p. on a commitment to set the forthcoming cuts at the same size, so that the SELIC rate will reach 11.75% in December this year. If this second interpretation is correct, there will be no reasons to complain about the Central Bank by Lula and other members of the government at year-end. But the jury is still out regarding possible negative side effects. In the inflation targeting regime it is fundamental for expectations to remain anchored to the target, and if the Central Bank caves in once, it might well do so on other occasions.

Therefore, it will be necessary to monitor not only the evolution of the expectations of economists reflected in the Focus survey, but also those of traders built into the yield curve and implicit inflation rates. Based on an assumption, admittedly optimistic, of no additional unanchoring of expectations, we maintain our previous projection that the terminal SELIC rate will reach 9.5% in 2024.

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