Analysis: Dollar will be crucial for Brazil’s Central Bank committee

RIO DE JANEIRO, BRAZIL – The evolution of the value of the dollar against the real in the coming days, which opened today’s trading session under pressure, will be fundamental to the inflation forecasts that will support the decision of the Central Bank’s Monetary Policy Committee (Copom) next week.

As happened early last week, a lower dollar could help the central bank present an inflation forecast that is less far from the 2023 target, reducing pressure for more monetary tightening.

However, the dollar rose sharply on Friday after Federal Reserve Chairman Jerome Powell signaled that a 0.5 percentage point increase in the U.S. federal funds rate is on the table.

The Brazilian central bank intervened in the exchange rate, selling 571 million U.S. dollars. The measure was justified to maintain the functioning of the exchange rate, squeezed in a market session in the middle of an extended holiday. Ultimately, however, this avoided a higher dollar.

Another reason is uncertainties about the Chinese economy and the prospect of a tighter lockdown of Beijing to contain the recent wave of coronavirus infection in the country. Iron ore prices were down about 10% on Monday.

The dollar is not directly related to monetary policy, but it has gained importance recently for two reasons.

One of them was the statement of the president of the Central Bank, Roberto Campos Neto, that the market sectors did not consider the new – lower – dollar rate in their inflation forecasts.

Since March 25, when the Central Bank staff strike began, there has been no reliable indicator of the market’s inflation forecasts. However, informal surveys, such as the one conducted by XP Investimentos, suggest that the market’s inflation forecast for 2023 may have risen to 4%, while the inflation target for this year is 3.25%. The Central Bank promises to publish Focus tomorrow.

Another fact that makes the dollar exchange rate more visible in monetary policy decisions is that the so-called pass-through of exchange rate fluctuations to inflation has increased.

A 10% increase in the dollar exchange rate has a maximum impact of 1.1 percentage points on inflation over 12 months. Over a more extended period, between 18 and 21 months, this effect is reduced to 0.6 to 0.7 percentage points.

That can make a big difference. Last week, the dollar hovered around R$4.60, 8% below the market consensus, which is close to R$5.00 according to informal surveys.

This means that the inflation forecast for 2023 is about 0.5 percentage points lower. This could help Copom present an inflation forecast closer to the target.

Expected inflation under relative control would prevent the policy rate from moving further away from the 12.75% per year that Copom signaled in March for the end of the tightening cycle.

With information from Valor

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