MNI INTERVIEW: BCB 'Dovish Hike' Could Backfire - Volpon

MNI (BRASILIA) - The Central Bank of Brazil is likely to raise the official Selic rate by 25 basis points to 10.75% on Wednesday, former deputy governor for international affairs Tony Volpon, told MNI, stressing that the accompanying messaging will be key and that that a "dovish hike" could end up extending the length of the hiking cycle.

"It is very likely that BCB will raise interest rates. There are three key factors the central bank considers when determining whether its monetary stance is appropriate, and all three are misaligned," said Volpon, now a professor at Georgetown University, pointing to market pricing, inflation expectations above the 3% target for all relevant timeframes, and economic activity running above potential.

While the Monetary Policy Committee (Copom) is likely to stop hiking at 12%, this will depend on how it handles its communications, he said. (See MNI INTERVIEW: BCB To Begin Short Hiking Cycle -Megale)

DOVISH HIKE

"They are giving the impression of being forced into raising rates, and we need to see if they will correct that. My concern is that they might implement a shy dovish hike, which would be very problematic," the former deputy governor emphasized.

Tightening needs to be as impactful as possible in terms of expectations and market pricing to reduce the need for future hikes, Volpon said.

"Otherwise, the effect could be the opposite, with rates going up but the exchange rate depreciating further and expectations becoming even more unanchored.”

In his view, it is crucial that the hike be accompanied by a hawkish tone. "It can't be something timid or conditional.”

Volpon also noted market’s doubts about the upcoming transition at the BCB, with current director for monetary policy Gabriel Galipolo set to replace Governor Roberto Campos Neto early next year.

In July, the BCB unanimously decided to hold the Selic at 10.5% for a second consecutive meeting, offering no forward guidance for the next sessions. However, minutes from the meeting indicated that Copom would "not hesitate" to hike rates if necessary.

MARKET PRESSURE

Volpon pointed to significant market pressure, driven by a weak exchange rate, implied inflation derived from government bonds well above target, and inflation expectations signaling an upward trend across all relevant timeframes.

Additionally, he observed that the BCB doesn't appear to have fully embraced the idea that the economy is operating above its potential, despite projected growth exceeding 3% in 2024, combined with low unemployment.

"The central bank has indicated that it doesn't provide forward guidance and is data-dependent. The latest data show that the economy is indeed operating above its potential. This should settle the discussion and justify the rate hike," Volpon concluded.