Finally, the start of a monetary easing cycle

BRAZIL ECONOMICS - Report 24 Jun 2019 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

At the last COPOM meeting, the Central Bank kept the SELIC rate at 6.5% but left the door open for a cut in July, which should happen with or without approval of the pension reform by that date. Although inflation accrued over the past 12 months is above the target, reaching 4.7% in May, this is almost all due to shocks in food and oil prices. With the economy subdued, those shocks are mere noise that will dissipate quickly, and should not be considered in the monetary policy decisions. With the current economic cycle already having reached its sixth year, with GDP standing 5 percentage points below the previous peak (9% below when considering per capita GDP), there are no doubts that the output gap is negative and large, requiring monetary stimuli to reduce it. Monetary policy alone cannot assure a return to sustained growth, but if the Central Bank refuses to increase these stimuli, it will run the risk of keeping inflation persistently below the target, at the cost of a stubbornly depressed economy. In our last Quarterly Outlook we projected an overall decline of 100 basis points in the SELIC rate, but in light of the latest data, this drop can (or should) be greater.

In May, inflation over the past 12 months was 4.7%, slightly above the target, but this was due to shocks in food and oil prices. The core measures showed a much more favorable situation, which is to be expected based on the ample slack capacity in the economy.

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