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Central Bank ends easing cycle, but leaves door open for new cut

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Vincent

The statement released by the Central Bank's Monetary Policy Committee (Copom) after its decision to cut the Selic benchmark interest rate by 25 basis points to 2% represents the end of the monetary easing cycle, but leaves the door open for more cuts if there are positive inflation surprises. The committee also provided forward guidance that it would keep the interest rate low for a long time.

The scenario outlined by the Central Bank (BC) apparently doesn't allow room for additional stimuli, considering the combination of inflation projections and the asymmetric balance of risks. But the BC possibly sees a good chance of developments that would render its baseline scenario outdated.

It is worth noting that the 2022 inflation target is now on the Copom's radar, even if to a lesser extent. It entered prematurely. Up to now, the Copom's habit was to only say in October of each year to that it was beginning to pursue the target two years down the road, and to a smaller degree. This time, they decided to anticipate this target by two meetings.

The statement doesn't explain the reasons for this rush to pursue the 2022 target. At first sight, it doesn't make much sense, because the maximum effect of monetary-policy decisions has a lag time of a year and a half to two years. One plausible explanation is that the Central Bank is concerned about maintaining control over long-term inflation expectations, which, in a context of strong fiscal uncertainty, could come unmoored. Another possible explanation is that it provides support for the forward guidance that says rates could stay low for a long time.

The fact that the BC is also starting to look at the 2022 target makes all the difference. The BC's inflation projections for 2021, which up to now was the only target of its monetary policy, are at 3% in two of its scenarios: one with stable interest rates at 2.25%, and another with rates that fall to 2% and rise to 5% in 2022. At 3%, the projected inflation is well below the target, set at 3.75%.

The Central Bank had already been warning analysts to look at the low projections for 2021 in the baseline scenario with some reservations, since the balance of...

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