MNI INTERVIEW: BCB To Begin Short Hiking Cycle -Megale

MNI (BRASILIA) - The Central Bank of Brazil is likely to hike the Selic rate by 25 basis points to 10.75% next week, beginning a short tightening cycle, as economic activity surprises to the upside and inflation expectations remain elevated, former secretary of industry and commerce development at the economy ministry Caio Megale told MNI.

"Since mid-last month, we changed our base scenario to a rate hike in September. This is based on two main factors: the evolution of the data and the communication from the Copom members," Megale said in an interview, adding that the tightening cycle is likely to be short because rates are already high.

"It's just about tightening a bit more. We're not too far from the final level," highlighted. Megale, who was also director of programs at the economy ministry from 2019 to 2020 and is now chief economist at XP Investments. He said Monetary Policy Committee Copom was likely to move fast to avoid having to stretch out rate hikes over a greater length of time.

"Our call is that the cycle will total 1.5 percentage points, with one 25bp hike, two 50bp hikes, and a final 25bp hike. This makes more sense than six 25bp hikes, which would prolong the process too much," he said.

STRONG ACTIVITY 

Economic activity has continued to surprise to the upside, showing a significant increase in demand, Megale said. (See MNI INTERVIEW: BCB To Hold Rates For Now Despite Worse Outlook)

"Wages are rising, indicating higher production costs. The latest data on retail sales and services point in the same direction. On the cost side, there’s currency depreciation. With rising costs on one side and strong demand on the other," he said.

Inflation expectations also remain above target, he added. "Inflation itself has been coming in above the target. So, inflation is above the target, and the projection is that it will remain above or increase. In this scenario, the central bank, which targets inflation, is likely to react and raise interest rates."

HAWKISH COMMUNICATION

Copom members have also expressed concern over this inflation trend, Megale recalled.

"They said if it’s necessary to raise rates, they will, with no restrictions, and Governor Roberto Campos Neto mentioned that if they initiate a rate hike cycle, it will be done gradually, signaling the pace of the increases.”

In Megale’s view, Copom is unlikely to start the cycle with a 50bp hike. "Not all factors suggest inflationary pressure. Commodity prices in the international market have fallen. This brings some relief. Gasoline prices will likely drop, and food prices have decreased in the short term, with the potential to fall a bit more. The Fed is going to cut rates, but we don’t yet know the exact impact of that.”

INFLATION BELOW THE TARGET

When when analysts input variables into the central bank’s model, a 12% rate brings inflation below the target by 2027, he said.

"By 2026, rates should return to neutral, between 9% and 10%. Given the uncertainty, I’d say 2025 will see rates at 12%, and 2026 at 9.5%, to ensure inflation really comes down, and the Central Bank has room to cut rates further down the line. However, based on the model, they could start cutting rates as early as August or September of next year," said Megale.

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