MNI INTERVIEW: Hawkish Copom Hints At Prolonged Hold-Kawall

The Central Bank of Brazil is likely done lowering interest rates for now after its unanimous decision to hold its official Selic rate at 10.50% Wednesday was accompanied by a hawkish statement, though Copom is likely to begin a fresh round of easing next year, former Treasury Secretary Carlos Kawall told MNI.

"Copom stressed that the unanchoring of expectations had worsened, and that monetary policy needs to remain contractionary for long enough to consolidate disinflation and reanchoring," Kawall said in an interview. "We have a call to maintain the Selic rate until the end of the year and a new rate cut cycle next year, which is closely linked to what we imagine might happen in U.S. monetary policy. So, we have the Selic rate falling by another 100 points to 9.5% next year.”

The statement included the word "vigilant," which Kawall said is usually used to signal that it is more likely to hike rates than to cut them -- although he still does not expect the BCB to revert to tightening.

"I highlight the paragraph in which the committee says it will remain 'vigilant' and reminds us 'as usual' that any future adjustments in the interest rate are dictated by the firm commitment to the convergence of inflation to the target. The word vigilant in this context suggests the possibility of having to raise the Selic rate if the situation worsens," said Kawall, who served as Treasury Secretary during an earlier term in office by current President Luiz Inacio Lula da Silva in 2006 and is now a partner at investment manager Oriz.

Kawall noted the statement also includes a paragraph on how recent developments in fiscal policy impact monetary policy and financial assets, with a reference to the exchange rate.

SUFFICIENTLY RESTRICTIVE

But some dovish caveats indicated that additional hikes are not likely on the table.

"I believe we will not reach the point that Copom will need to raise rates, it is not the base scenario. I also don't think we will see a significant improvement in inflation expectations to cut more this year. And the global backdrop obviously matters a lot."

One alternative scenario presented by the BCB, with the Selic stable at the current level until the end of next year, would lead to an inflation rate of 3.1% in 2025, close to the 3% target, showing that holding rates would be enough, Kawall said.

"The important thing is that the committee added an alternative scenario with the Selic rate constant over the relevant horizon and inflation at 3.1% in 2025. I think the intention here is to show that keeping the Selic rate steady is sufficient over the relevant horizon to make inflation converge to the target of 3% next year.”

The 2025 inflation projection was also fairly moderate, rising only 0.10 percentage points to 3.4%, below expectations. The BCB presented risks to the outlook as balanced, with inflation seen as just as likely to rise or fall in the future.

UNITED WE HOLD

Copom’s decision to keep interest rates on hold for the first time after nearly a year of aggressive easing was unanimous, in contrast with the split vote for a 25bp cut in May, when four dissenters called for a 50bp reduction. (See MNI POLICY: BCB Pause In Sight, But Copom Consensus In Doubt)

"Considering what happened at the last meeting, with the divided votes, I think it was a consensus-building effort that will greatly help market interpretation," Kawall said. (See MNI BCB WATCH: Copom Signals End of Easing Cycle, Not Pause)

But concerns over fiscal policy, compounded by government attacks on the autonomy of the BCB, are a serious problem, he said.

"If the Copom had been divided again, the situation would not have much room for improvement. But unanimity is not enough.”