Thought August 06, 2019 / 01:34 pm UTC

Brazilian Central Bank: Not as Dovish as the Market Sees It

By Pedro Tuesta

The minutes from the July 31 monetary policy meeting show that the Brazilian Central Bank (BCB) saw room to cut the Selic rate, the country’s overnight rate, but will be cautious going forward. Importantly, the global backdrop has changed substantially since the decision was made, which could change the outlook for upcoming meetings. 

There are two main takeaways from the July 31 BCB meeting minutes. First, the decision to cut the Selic rate to 6.00% was taken with a much more benign global backdrop, as seen by the assumption that BRLUSD will remain at 3.75 for the rest of the forecasting period. Now, BRLUSD is quoted at 3.95, which could add at least 40 bps to the inflation forecast if the depreciation is not reversed.

The second takeaway is more nuanced. The minutes use three paragraphs to discuss the possible impact of Brazil's pension reform on structural rates. The BCB concludes that, initially, the pension reform could increase the structural rate by increasing demand for investment. In the long term, the reform will help to reduce the structural rate via risk premium reduction. Our interpretation of this conclusion is that the BCB will be cautious in easing the Selic rate until it is clear that the net impact has tilted toward a lower structural rate.

Also worth noting is that the BCB, while assessing a more favorable outlook for inflation, did not change its view that the risk of higher inflation remains larger than that of lower inflation. As we mentioned, an important component of the improvement in the inflation outlook was the improved global backdrop. However, that has now changed, so we will not change our view that the BCB will be cautious in cutting rates below 5.75%. If global conditions improve again, we will adapt our call to include more rate cuts.

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Analyst Certification
I, Pedro Tuesta, the lead analyst certify that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further certify that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.