In March, the BCB started reducing the historically large monetary stimulus that was adopted to tackle the economic effects of the pandemic (Figure 1). At that meeting, the Bank signaled that another 75bps rate hike of the same magnitude will most likely happen in the May meeting. And more recently, in mid-April, BCB president Roberto Campos Neto reaffirmed that “unless something extraordinary happens, the BCB does not see anything different than 0.75ppts [for the May meeting]”.
Two issues have the potential of shifting the BCB stance: inflation (actual and expected), and the fiscal strategy. Inflation has continued to increase. In H1 April it reached 6.17% and it will probably be around 6.8% by the end of April. Indeed, headline inflation will probably continue increasing through July-August. That said, this trajectory is already part of the BCB's headline scenario. For its part, inflation expectations have increased marginally in the past weeks, but only to approach the BCB estimates. The fiscal situation has been much noisier on the back of the health crisis, with some issues about the 2021 budget still unresolved. However, in the last days of April optimism about progress on the administrative and tax reforms, which are a pre-requisite to long-term fiscal consolidation, was renewed.
In this light, we don’t believe either the inflation or the fiscal issues merit a change in the BCB stance for the May 5 meeting. Looking ahead, we expect the tightening cycle to continue in the June, August, and September meetings, but with smaller adjustments of 50bps. We then expect the Bank to pause the tightening in the October and December meetings, supported by an inflation slowdown from September. The main risk to our 5.0% end-of-year view for the policy rate is to the upside if higher commodity prices prevent a decline in inflation or the fiscal outlook deteriorates again.