BCB to resume interest rate hike, Societe Generale's model supports higher Selic rate

Selling pressures in emerging market currencies will likely remain in the near future. The current political chaos will maintain the pressure on Brazil's economy and, as a consequence on the real. The BCB has been on the sidelines since late July but it likely expected to resume the interest rate hiking process to try to anchor inflation expectations, in spite of a worsening recession. 

Societe Generale's estimated BCB reaction function model puts the Selic rate at 15.9% in Q415 compared with 14.7% in Q315. Assuming that inflation falls in H1 this year (as the effect of adjustments to regulated prices ebbs), the model suggests a sharp cut in the Selic rate in H1. In fact, the model suggests a Selic rate as low as 12.5% in Q416 (assuming inflation and inflation expectations moderate sufficiently).
 
Based on Societe Generale's model, we expect BCB to raise rates now to prevent inflation expectations from rising, and then cut rates in H216. It would be worth mentioning here that the decision to hold rate in the last copom meeting was not unanimous.