Brazil Copom minutes – No constraint, but not yet ready to hike rates

The main message the Copom sends to market observers with today's minutes is that it can raise the interest rate despite the path of other macroeconomic policies. According to our interpretation, by doing so the board wants to dismiss the idea that the monetary policy is constrained due to the fiscal policy, aiming to contain inflation expectations' upward trajectory. More importantly, although the board signals that it could hike the Selic rate, it does not indicate it will necessarily do so in the next meeting. The majority of the board preferred to monitor the evolution of the macroeconomic outlook until the next meeting and then define the next steps for monetary policy strategy, which leaves it in data dependent mode. And the recent news of the Q3 real GDP report and the start of the impeachment process of the president increase the uncertainty and could make the board wary of resuming the tightening cycle.

The board reaffirmed the commitment to keep inflation within the target range in 2016 and to bring it to the mid-point of the target by 2017. In the board's reading, inflation expectations are increasing due to the looser fiscal policy and upside surprises in the regulated prices. There is a high uncertainty regarding the pace of improvement in the fiscal accounts, and as such two members of the board wanted to immediately adjust the monetary policy, by voting in favor of a 50bp increase in the meeting, in order to reduce the risks of missing the inflation target in the next two years.

Inflation forecasts increased from the previous meeting in the BCB models. The assumptions for regulated prices were increased to 17.7% and 5.9% for 2015 and 2016 (from 16.9% and 5.8%, respectively), while the exchange rate considered in the reference scenario (in which variables are kept stable throughout the forecast period) was reduced to USDBRL 3.80, from 3.85 previously. The largest change in terms of assumptions, though, came from the fiscal side, incorporating a 0.85% of GDP deficit for the fiscal primary result this year (from a 0.15% surplus previously), while keeping a 0.7% primary surplus in 2016. Under these assumptions, inflation forecasts were increased both this and the next year, while remaining near the mid-point of the target by 2017.

"We maintain our expectation of no change in the Selic rate in the next meeting, reckoning that the risks are for rate hikes rather than the opposite. The long gap until the next meeting, due to be held on January 20, leaves ample room for further uncertainty and volatility as the political events unfold. More importantly, the inflation releases, behavior of inflation expectations and also the Quarterly Inflation Report, due to be published by the end of the month, will be crucial to determining the next steps of monetary policy", says Barclays.