RIO DE JANEIRO, BRAZIL – To contain escalating inflation in the United States – which closed last year at its highest level in 40 years, amid bottlenecks in production chains exacerbated by the pandemic – the US Central Bank, the Federal Reserve (Fed), plans to start a new short-term cycle of interest rate hikes.
The US monetary authority has signaled that the first increase since 2018 should be announced at the March meeting, when it is expected to also suspend the financial stimulus it has been launching in the economy to tackle the impacts of the pandemic on economic activity.
RISK FOR BRAZIL
As the world’s largest economy, a change of direction in the US monetary policy reverberates in all corners of the globe. Brazil is not excluded.
With higher American interest rates, a migration of part of the dollar entering Brazil as well as other countries, is expected to move to the United States. With fewer dollars in the country, the American currency tends to appreciate against the Brazilian real, thereby pressuring local inflation.
“An interest rate hike in the United States can, in a first moment, impact Brazil by pushing up inflation,” says Ativa Investimentos chief economist Étore Sanchez. Exchange rate variations have a great impact on the price index in Brazil, which depends on imported raw materials to produce the most varied items.
An example of this are fuel prices, largely responsible for the peak in inflation last year, and whose readjustments are in line with the international price of oil, at record highs.
As the official inflation ended last year well above the target ceiling – which had not happened since 2015, the scenario becomes more worrying and raises the question: is Brazil prepared for a new period of monetary tightening in the United States?
CAN BRAZIL HANDLE THE NEW CYCLE?
It is difficult for Brazil to come out of this fully unscathed, but economists consider that Brazil’s Central Bank has anticipated raising the SELIC rate more intensely and quickly, which means that the country will be able to calmly cope with future hikes in US interest rates, since the monetary tightening in Brazil has put the brakes on an even stronger appreciation of the dollar.
According to Sanchez, the Central Bank has a “powerful” monetary policy that has had “its relevance increased in recent years.” The economist believes that “the interest rate hike by the Central Bank is enough to control the inflationary advance and inflation expectations.”
Another point that could mitigate the rise in interest rates in the United States is the anticipation by the market. As it is an expected trend, it has already been “priced in,” in market jargon, according to Veedha Investimentos chief economist Camila Abdelmalack. “What may occur is if the bank adopts a more aggressive posture than the one it has already been signaling,” she said.
The expert also recalls that, in the case of the stock market, “despite the signals of an increase by the Fed, there is still a lot of foreign investment flow in variable income in Brazil.” According to the economist, this is an indication that Brazil is proving to be a reliable market for investors.
REMAINING CHALLENGES
Even though the high interest rates in Brazil have the power to mitigate the appreciation of the dollar in the country, experts say that it is still not enough to stop the impact of the stronger US currency on prices.
According to Eleven Financial economist Thomaz Sarquis, although the country has proven more cautious with its fiscal health after the 2015-2016 recession, there are still risks in this sector. “Accounts are still in a fragile situation and we are far from inflation targets,” he said.
The economist believes that the exchange rate and the price of commodities must be monitored. “The main problem is that most commodities have risen considerably in price, which ultimately neutralizes the effect of the exchange rate on inflation in the short term.”
Sarquis sees it as a challenge for Brazil to approve reforms that aim to curb the spending trajectory, since a fragile fiscal situation exposes the country to external risks. “However, any packages and measures in the works today are much more based on a spending perspective rather than saving.”
THE LAST RATE HIKE CYCLE
The last interest rate hike cycle in the US occurred between 2016 and 2019, when the rate, which is worked in intervals, stood between 2.25% and 2.50%. Economist Thomaz Sarquis notes that at the time, during the administration of ex-President Donald Trump, one of the most famous measures was tax cuts.
“By cutting corporate taxes, a boost in aggregate demand occurs. As a result, investments soared, economic activity surged, generating an inflationary counterpart, although nowhere near what we see today. But the Fed needed to offset this very strong effect it was having on economic activity and raised interest rates,” Sarquis explains.
Another factor that caused the increase was the trade war between the United States and China. The tariff conflict caused US inflation to be high, resulting in the need to exercise this fiscal policy.
Most market analysts expect the US interest rate to experience 4 hikes in 2022, rising from the current range of 0% and 0.25% per year to 1.25 to 1.5%, with further hikes expected in 2023. The new meeting of the US central bank is scheduled for March.
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