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Yesterday, the BCB’s Monetary Policy Committee (Copom) met for the first time this year and for the first time with two new directors: Rodrigo Alves Teixeira as the new Director of Administration and Paulo Picchetti, as the new Director of International Affairs.
Despite the new developments, everything seems to be following the pre-established path since the end of last year and the BCB finally decided unanimously to cut the Selic rate by 50 basis points for the fifth consecutive time, to 11.25%.
While the statement accompanying the decision was still relatively comfortable with the evolution of core inflation, we believe that this time it was somewhat more conservative in acknowledging that, despite progress, the current situation “requires caution”, implying that there is still work to be done.
While the statement also showed that all Directors expected the pace of rate cuts to be sustained for the foreseeable future should the Bank’s baseline scenario materialise, we continue to believe that a slowdown in the pace of rate cuts towards the end of the year is not out of the question, especially if the upward price pressures seen in recent months persists.
Overall, we believe that the rate statement was slightly more hawkish than in December, as the BCB’s choice of words and guidance suggests that the pace of rate cuts will be maintained after yesterday’s meeting probably through the first half of the year but with risks skewed to the upside towards the end of the year. While the overall impression remains that the authorities are comfortable with the recent advance in inflation coupled with the recognition of a “less adverse” external environment and a slowing domestic economy, in line with their forecasts, Copom has urged caution and recalled that we are at a stage in the disinflationary process that tends to be slower.
This is in line with our view that the recent trend in inflation will keep the BCB vigilant. December’s monthly data again showed only a marginal deceleration in headline inflation which, in our view, casts doubt on the hypothesis that the mini inflationary peak that started after the summer months is behind us.
While some of the more inflationary categories may not pose an excessively high risk of inflation worsening in Brazil, we believe that, especially given the still uncomfortably high level of core inflation in services, the headline rate may continue to decline more slowly than many think and than the BCB would like. However, Copom has made it clear that there is insufficient evidence to deviate from its current roadmap.
As a result, and although we believe that the 50 basis points pace of cuts will be the Copom’s choice for the first meetings of 2024, we believe that the risks for a slowdown in the pace of cuts in the second half of the year remain to the upside, which would see the Selic rate cut less than most anticipate over the course of 2024. This should be supportive of the real, as has been the case with the real opening only slightly lower amidst a backdrop of broader USD strength this morning at the local market open. This, coupled with the decision to maintain explicit forward guidance to support investor sentiment, not only continues to support the credibility and effectiveness of BCB policy, but also the real.
Nevertheless, for the BCB to spur renewed upside in the BRL, a more notable hawkish shift will be required, which we don’t expect to occur until the Selic rate tracks much closer to estimated levels of neutral later in the year.
Author:
María Marcos, FX Market Analyst