MNI INTERVIEW: Copom To Accelerate Rate Hike Pace To 100BP

MNI (BRASILIA) - The Central Bank of Brazil is likely to accelerate its pace of rate hikes to 100 basis points on Wednesday, raising the Selic rate to 12.25% following a negative market reaction to the government’s recently-announced fiscal package, former Treasury Secretary Jeferson Bittencourt told MNI.

"We believe the Copom will raise the Selic rate by 100bp at the next meeting and continue increasing it until it reaches 14%. This is already higher than what was expected before the announcement of the package. In other words, we’re already projecting a path that reflects a reaction to the conditions brought by the package announcement," said Bittencourt, now head of macroeconomics at ASA Financial Institution.

The central bank had already increased the size of its rate increases to 50bp at its last meeting, when it raised the Selic to 11.25%. Given the fiscal backdrop, this pace may no longer suffice, Bittencourt said. (See MNI INTERVIEW: BCB Hurt By Fiscal ‘Blunder’ - FGV’s Goncalves)

The real has fallen since the announcement in late November by Finance Minister Fernando Haddad of a package including BRL70 billion in spending cuts over the next two years, sending the dollar climbing to around BRL 6 from 5.81. "The negative reaction came from the signal that the government is not willing to use its political capital to address the economy’s imbalances. This is evident from the fact that the package was presented with an election campaign tone," Bittencourt said.

"It’s necessary to show a willingness to sacrifice short-term gains for long-term benefits. Only then might it be possible to return to the asset price levels seen before the announcement," he said.

MARKET REACTION

Haddad argued that the package, which included an increase in the income tax exemption threshold for individuals up to BRL5,000 per month, from the current BRL2,259.20, would have a neutral fiscal impact, as it includes higher income tax rates for those earning over BRL50,000 per month. However, investors point to uncertain revenue estimates and question whether the measures are sufficient to prevent further fiscal deterioration.

Bittencourt said that a broader risk premium was embedded in Brazilian assets, driven not only by fiscal concerns but also by doubts over the central bank’s credibility. "There is still an important component stemming from uncertainty about how the government might react if the central bank rigorously fulfils its role of cooling down the economy," he added.

Third-quarter GDP figures released last week showed a stronger-than-expected 0.9% growth compared to the previous quarter. (See MNI INTERVIEW: BCB May Speed Up Hikes After Fiscal Package)

"The GDP data confirms a scenario of robust economic activity, which would pressure monetary policy even if fiscal policy weren’t so uncertain. Even if the fiscal outlook were less critical, the central bank would still face challenges due to the strength of economic activity," Bittencourt explained.