MNI INTERVIEW: Lower Inflation Could Hasten Copom Cuts-Werlang

The Central Bank of Brazil is most likely to maintain or reduce the pace of its easing cycle, currently at 50 basis-points per meeting for the time being, but it is not impossible that it could press on the accelerator to 75bp should inflation continue to surprise to the downside, the BCB’s former deputy governor for economic policy Sergio Werlang told MNI.

"If inflation data remains lower than expected, I don't see why the BCB cannot accelerate the pace of rate cuts. But I would say that the most likely scenario today is to continue at the same pace, mainly considering the good inflation numbers that have been seen recently, and the board has indeed opened the door to a [possible] slowdown," Werlang, now a professor at Fundacao Getulio Vargas, said in an interview. (See MNI INTERVIEW: New Brazil Guidance Doesn't Mean Slower Easing)

IPCA inflation fell to 3.93% in annual terms in March, down from 4.50% in February, the sixth consecutive monthly deceleration in the 12-month accumulated series to the lowest level since June 2023. Core inflation also moderated.

"I think the terminal rate will reach a number between 8.5% and 9%. I haven't changed my forecast yet because the inflation numbers are coming in very good," commented Werlang.

Following a 50 basis-point cut in the Selic rate to 10.75% last month, Copom members indicated they expect an additional cut of the same size at the "next meeting" in May, after previously saying half-point moves were forthcoming at the "next meetings."

According to the minutes, "some members" of the board argued in favor of a deceleration in the easing cycle pace if "uncertainty remains high in the future.” So far, official documents and speeches by Copom members have avoided any indication of the easing cycle’s low point.

"I think in terms of the terminal rate, this change in guidance itself has little to say. Anyway, the terminal rate will be very determined by current inflation and by expectations," Werlang said, adding that the shift in policy communication was an attempt to gain flexibility.

INFLATION TARGET TOO LOW

In his view, the 3% inflation target is too low and the cost in terms of lost activity of reaching the goal would be too high. (See MNI INTERVIEW: Hawkish BCB Even More Data-Dependent - Volpon)

"This target is too low, but the central bank is in a trap because changes to the target, when they have happened in the past, only took place when there was help from the fiscal side. This is something we are not having now. So, signaling a change to the inflation target may have a negative effect," he said.

Werlang noted that potential growth might have increased in recent years to around 2.5%, slightly above the market consensus estimate of 2%.

"Potential GDP is not spectacularly high but is within the range of 2.5% to 3%. Since GDP growth expectations for this year are around 2%, we would still be below potential, meaning the output gap would still be opening, and therefore there wouldn't be much inflationary pressure from activity."

Regarding the heated labor market and possible pressure on service inflation discussed by Copom, Werlang argued that increases in government benefits after the pandemic reduced the number of people looking for work and contributed to reducing the unemployment rate.

For him, the equilibrium unemployment rate – NAIRU -- may be close to 7.5%. Currently unemployment sits at 7.8%, still too low to generate inflationary pressure, in Werlang’s opinion.