Monetary policy minutes, inflation reinforce forecast for new rate cut

Two of the week’s most closely watched events for the interest-rate market—the minutes of the latest meeting of the Central Bank’s Monetary Policy Committee (Copom) and the release of July’s Extended Consumer Price Inflation (IPCA) inflation data—did little to alter investors’ expectations for the next moves in the Selic rate. With no significant new information to incorporate into the short-term outlook, the market maintained a firm expectation of another rate cut in September, while the continuation of the easing cycle after next month remains uncertain.

On the monetary-policy side, the minutes maintained the message that slowing economic activity and moderating inflation in recent months allowed the Copom to cut the Selic from 14.25% to 14% last week, even as risks stemming from supply shocks, expansionary fiscal policy, and unanchored inflation expectations persist and prevent a larger reduction in the Selic. Against this backdrop, the next steps will continue to depend on incoming data, according to the Copom.

“It was a very neutral set of minutes, very similar to last Wednesday’s statement,” said Flávio Serrano, chief economist at Banco Bmg. “The Central Bank is leaving the door open to any action [in September], and that will depend heavily on how the data evolve by then.”

In his view, a broad-based economic slowdown is important for the Copom to gain confidence in the effect that restrictive monetary policy is having on demand. Serrano also praised the shorter minutes, which helped make the communication “clearer” than that surrounding the previous decision in June.

Cristiano Oliveira, chief economist at Banco Pine, meanwhile, highlighted the acknowledgment of waning economic momentum and moderating inflation, which appeared in last week’s policy statement and was reinforced in the minutes. Given the view that the slowdown driven by high interest rates should continue, the bank revised its baseline scenario and now expects the Selic to end this year at 13.25%, down from its previous forecast of 14%.

Oliveira also highlighted the section of the minutes discussing supply shocks currently underway, such as those involving oil, or that could affect inflation, such as the potential effects of El Niño. According to the Copom, monetary policy will not respond directly to such shocks, but the committee will remain attentive to their secondary effects.

“The guidance is particularly relevant given the shocks associated with oil and climate, indicating that their direct impacts do not necessarily require a monetary-policy response, as long as they do not lead to broader spillovers into inflation and expectations,” he said.

For Serrano of Bmg, uncertainty over the impact of El Niño on food prices is among the main factors that, at first, would justify a more conservative stance from the Copom starting in the fourth quarter. He sees another Selic cut in September to 13.75% as likely, but does not expect additional cuts in the benchmark rate after next month.

“The scenario justifies rate cuts. A pause would also be warranted given the high level of uncertainty, but the data are evolving favorably, with economic activity and inflation slowing,” Serrano said, while noting that prices remain at levels incompatible with the target.

In this regard, July’s IPCA reinforced the qualitative improvement in inflation observed since May, according to the economist. The index rose 0.07% from June, slightly above expectations, which did not materially change the market’s optimistic assessment of a more benign short-term trend.

Serrano said that almost all of the upside surprise in the IPCA released Tuesday (11) was due to a somewhat stronger increase in food inflation. By contrast, prices for labor-intensive services and the average of core inflation measures were largely in line with Banco Bmg’s expectations. The negative point, according to the economist, was somewhat greater-than-expected pressure on underlying services inflation, but nothing that alters the positive deceleration trend seen in recent months.

With no change in the perception that inflation is easing, investors are pricing in a 73% probability that the Selic will be cut from 14% to 13.75% next month, versus a 23.5% probability of the benchmark rate remaining unchanged, according to the Copom options market at the close of Tuesday’s trading session. For the November decision, the outlook is less clear and, at present, the probability of the Selic remaining unchanged is higher than that of another quarter-point cut, at 51% versus 30%, respectively.