Question of the week: Is the monetary easing cycle in Brazil over?
A: The BCB’s policy board—COPOM—kept the Selic rate on hold at 2.00% on Wednesday, likely marking the end of the easing that started in July last year, with rates down 450bp in total. The Board, however, left the door open to further stimulus, in case the economic upturn falters and the inflation outlook remains benign. It makes sense, in our view, for the Board to wait and see if the recovery lasts and if—as we expect—the recent headline inflation uptick prove to be temporary.
Recent economic activity, labour market and inflation data all have surprised Brazilian policymakers' expectations, to the upside. But output remains about 10% below its pre-Covid level, and the virus nightmare is far from over. New cases and deaths are still falling slowly, but a second wave virus can't be ruled out, given the experience of other countries.
Looking ahead, all eyes will be focused in the near term on the lagged effect of the increase of wholesale prices on headline consumer inflation, as well as the behaviour of food prices, and the political and fiscal news, particularly related to the spending cap. Any modification on the latter would trigger a loss of confidence, forcing policymakers to hike, before the economic recovery is fully established.
Our base case is that the current fiscal policy stance will prevail, supporting a gradual, though substantial, consolidation post-Corona. This means that the constitutional spending cap framework will be supported. But risks remain and much hinges on a highly unpredictable Congress. The good news is that the government seems to be committed to delivering a sound fiscal picture despite the ongoing challenging circumstances. Accordingly, we expect interest rates to remain at 2.00% for the foreseeable future.<!--EndFragment-->
Senior LatAm Economist