Brazil’s Interest Rate Problem

Brazil’s Interest Rate Problem

Could a higher interest rate halt Brazil’s recovery?

Brazil’s Interest Rate Problem The 1% increase in the SELIC rate, the brazilian interest rate, was in line with market expectations. The ultimate question is whether the remedy against inflation (interest rate) can become a poison by halting the growth of the Brazilian economy.

It is worth remembering that Brazil is still going through a period of recovery due to the coronavirus pandemic and was coming from a still slow upturn after a period of recession between 2015 and 2016. The unemployment rate remains high, 14.7% in the first quarter of 2021, which represents 14.8 million unemployed, and the consistent recovery of companies is still in check.

The last meeting of the Monetary Policy Committee (COPOM) changed the target interest rate from 4.25% to 5.25%. It was the fourth rise in a row, but the first rise of 1 bps in the period. This shows the central bank’s growing concern with inflation, which has been holding well above the target ceiling for several months. In other words, the discourse that inflation is temporary, basically caused by an increase in electricity and fuels, and would converge to the target without any abrupt monetary policy movements, seems to be no longer conceivable.

The latest inflation data in 12 months, released by the Central Bank, is at 8.35% (June 2020 to June 2021). The market outlook, released by the FOCUS report, is that the Extended National Consumer Price Index (IPCA) will increase to 8.97% per year in July, peaking at 9.19% in August, with the annual target being of 3.75% per year, and could range between 2.25% and 5.25%. The market expectation, measured by the same report, is that the IPCA will end the year at 6.79% and that it will converge to the target throughout 2022.

The COPOM signaled that it should maintain the pace of SELIC increase at 1% at the next meeting and that it may raise the rate beyond the level considered neutral, that is, beyond 6.5% / 7%. Important market players predict the end of the high cycle with interest at 7.5%.

The trade-off between the level of economic activity and inflation must be carefully analyzed by the monetary authority. High inflation has a high political cost due to the inflationary memory and the population’s loss of purchasing power. On the other hand, price control via interest rates can cause lower growth (especially in a pandemic moment) and also affects the government’s popularity, despite the well-known delay for this movement to bring results. As 2022 elections approaches, the risk of electoral maneuvers increases, despite the Central Bank’s autonomy, which might not be full.

For Rafael Foscarini, Director of Strategy at Belo Investment Research, “the context of the pandemic increases the complexity of decision-making by the Central Bank. An indication of this is the correlation structure between economic activity and the level of social isolation, which has been varying over time with a downward trend. That’s what Google’s office mobility data show when compared to the Regional Economic Activity Index – IBCR”.

Belo Investment Research is an independent research company that combines traditional and alternative data to analyze market trends since 2020.

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