While the Government Blunders, Monetary Policy is Doing its Part, but Has Reached its Limit

BRAZIL ECONOMICS - Report 18 Jan 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

In our opinion, at its meeting this week the COPOM will maintain the SELIC rate at 2%, but will exclude the commitment to keep it at that level for an extended period (forward guidance). Since in real terms, the basic interest rate is lower than the neutral rate, monetary policy will continue acting to stimulate economic activity for some time, but the moment is approaching when the rate will be increased to assure inflation will converge to the target. However, from the standpoint of economic activity, monetary policy has reached its limit. An economic rebound depends crucially on mass vaccination of the population, and the government has been fumbling in this respect, at the same time a new wave of COVID-19 contagion is under way. Indications exist that growth in the fourth quarter last year was already eroded, and that the negative effects on the economy will be worse in the first quarter this year. With this, the projections for GDP growth in 2021 have been reduced from 4% to near 3%, given the available information so far. By negatively affecting Bolsonaro’s popularity, the government’s failure to formulate an effective vaccination plan, the virulence of the second contagion wave, and the worsening economic activity are together working to increase the risks of a disorderly fiscal reaction, with reflections on the exchange rate, hampering the Central Bank’s work.

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