Monetary Policy: the Risks Ahead

BRAZIL ECONOMICS - Report 29 Mar 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

In the last Inflation Report, the Central Bank detailed the reasons it decided to start the “monetary normalization” with an increase of 75 basis points in the SELIC rate, to be followed by another hike of the same magnitude. Although recognizing that the inflation of 5.2% in the 12 months through February 2021 was a surprise in relation to the basic scenario of the COPOM, of 4.43%, this difference is not cause for alarm, because it was due to a “shock” caused by the increase of commodity prices and the depreciation of the real. A decisive factor for the Committee’s option for a front loaded adjustment was its positive vision about economic recovery in the second half of the year, based on envisioned success of the Health Ministry’s plan to deliver vaccines. Because of the uncertainty about the effects of resurgence of the pandemic on economic activity and the low risk of unanchoring of expectations, our preference was for a persistent sequence of 50-point rises per meeting, to avoid “bets” about a variation of the intensity of each step at each of the successive meetings of the COPOM. On the positive side, however, with this movement the Central Bank has inhibited, at least for the time being, the speculation over the risk of fiscal dominance. The Report basically examines two risks. The first, of lesser importance, is of more intense deceleration of economic activity due to poor performance of the vaccination campaign and prolongation of the pandemic. The second, more important, is the deterioration of the fiscal picture. It is increasingly clear that the deviation in relation to the spending cap will not be limited to the supplementary credit of R$ 44 billion earmarked for a new edition of the Emergency Relief program. There is a very strong risk that the spending cap will be exceeded by a much greater margin, which will increase the pressure on the exchange rate, prompting a longer and more intense tightening cycle.

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