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quinta-feira, março 29, 2012

Brazil 2Q2012 Inflation Report : CB reaffirms signal on monetary policy but says nothing on FX policy

Brazil 2Q2012 Inflation Report : CB reaffirms signal on monetary policy but says nothing on FX policy

Source: HSBC

The main message of the Inflation Report is, in our view, to reaffirm the signal that the Selic policy rate would fall to 9%, in line with the minutes of the minutes of the March Copom meeting. The report provides interesting insights into the Central Bank's views, but the discussion on FX policy is conspicuously absent. For that reason, we expect the report to have a limited impact on market expectations.

The main message of the 1Q2012 Inflation Report published by Brazil's Central Bank earlier this morning, in our view, was to reaffirm that the Selic policy rate would fall to "just above its all-time low level and remain there for an extended period of time" (which translated, almost certainly means "the Selic will fall to 9%, and stay there") - in line with the minutes of the March monetary policy committee (Copom) meeting. Overall, the discourse of the Central Bank is similar to recent documents, and reflects a benign view regarding the outlook for inflation. For that reason, we believe that the Inflation Report will have a limited impact on market expectations for monetary policy.

According to the Central Bank, the Brazilian economy remains below its long-term potential, but the outlook for economic activity is positive. For 2011, the Central Bank says that economic activity declined faster than it anticipated, and attributes this to the tightening of monetary policy and macro-prudential measures implemented at the end of 2010 and the beginning of 2011, made worse by the deterioration of the global economic outlook in 2H2011.

Looking forward, the Central Bank says it believes that the outlook for investment is favorable, particularly in the infrastructure and oil and gas sectors, while private consumption will continue to be supported by a strong job market and credit growth. It therefore expects economic activity to accelerate over the remainder of 2012, also in response to the policy easing administered so far this year and the improvement of business and consumer confidence.

With regards to risk factors to the inflation outlook, the CB says it believes that the risks associated to the divergence between supply and demand have diminished. Using phrases similar to past documents, the Central Bank also recognizes the risks associated to the tight job market and wage increases outpacing productivity growth. Also as in previous documents, the Central Bank says that it considers meeting the targets for fiscal policy (primary fiscal surplus for the consolidated public sector of about 3.1%/GDP for 2012 and in the next few years) a key assumption for its inflation scenario.

When discussing credit, the Central Bank says it considers it "opportune to introduce initiatives to moderate the concession of subsidies through credit operations". There is no further explanation for this phrase, but it could indicate that the Central Bank would prefer the BNDES to reduce lending or that it would prefer the government not to lower the TJLP rate (which is set directly by the government, is not sensitive to monetary
policy, and which serves to index most BNDES loans). In any case, the National Monetary Council (the body that sets the TJLP) meets today, and there has been some noise that the government was considering to lower it from 6%, where it has been since July 2009.

Risks associated to the rise of longer-term inflation expectations are also mentioned briefly in the report, but not discussed. This is the most important difference between our more cautious view regarding the medium-term outlook for inflation and the Central Bank's scenario. In our view, the erosion of the long-term inflation expectations anchor (reflected in the recent increase of the consensus forecast for the 2013 IPCA to about 5.5%) will make it more costly for policy to achieve the convergence of inflation to the center of the official target (4.5%).

Another interesting point which the Central Bank touches on briefly, but does not discuss has to do with growth smoothening. When describing its views regarding the lags in the transmission of monetary policy (to which it also dedicates an entire box in the report), the Central Bank points out to the fact that the effects of changes in policy are cumulative, and that "these lags are taken into consideration when conducting monetary
policy, in part, to avoid unnecessary fluctuations of economic activity". In our view, this phrase reinforces perceptions that the CB's policy reaction function now attributes a higher weight to minimizing the output gap than was the case historically.

Turning to inflation forecasts, in the reference scenario (which assumes the policy rate to remain unchanged at 9.75% and the BRL at 1.75/USD through the end of 1Q2014, the Central Bank forecasts that the IPCA will end 2012 at 4.4% and 2013 at 5.2% (falling to 5.1% at the end of 1Q2014 - the longest-term forecast available). This implies a 30 bps decline in the 2012 forecast relative to the previous report, but a 50 bps increase in the 2013 forecast.

However, since the CB sent a strong signal that it expects the Selic policy rate to fall to 9%, we believe investors should pay closer attention to the Central Bank's forecasts based on the "market scenario". This scenario is constructed using the market's consensus for the Selic policy rate and the exchange-rate through the end of 2014. In this scenario, the Selic rate is assumed to fall to 9% in 2012, and to rise to 10% at the end of 2013, and the IPCA is forecasted to end 2012 at 4.5%, and 2013 at 5.3% (before falling to 5.2% by the end of 1Q2014). This implies in a 30 bps decline in the 2012 forecast relative to the previous report, and no change to the 2013 forecast.

Overall, although the Inflation Report contains interesting insights into the Central Bank's views on the transmission of monetary policy, we expect it to have a limited impact on market sentiment and believe it to be consistent with our own forecast for monetary policy, namely that the CB will cut the Selic policy rate by 75 bps to 9% on April 18, and keep it at that level for an extended period of time. However, we also believe that economic activity will accelerate significantly in 2H2012, and that the medium-term inflation outlook remains a significant risk. For that reason, we expect the authorities to pursue a policy tightening through macro-prudential measures as early as 4Q2012, followed by modest rate hikes in the 2013 (bringing the Selic policy rate back to 9.75%).

What also calls our attention regarding the report is what was absent from the discussion. In the report, the Central Bank makes practically no reference to FX policy. In our view, concern about BRL appreciation was an important driver of the decision to accelerate the pace of easing to 75 bps per meeting at the last Copom meeting. Yet, the Central Bank keeps the discussion on that decision to a minimum, and makes no reference to the flurry of capital controls and other FX policy measures implemented in the last few weeks.

BOTTOM-LINE:

Overall, the Central Bank's discourse in the Inflation Report was similar to that of the minutes of the March meeting. The Central Bank reinforced the signal interpreted by the market that the Selic policy rate will fall to 9%, but made limited references to what led it to accelerate the pace of easing to 75 bps in March or to the changes in FX policy of the last few weeks. For that reason, we expect the report to have a limited impact on market expectations.

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