Brazilian Central Bank should maintain interest rates, but fiscal risk worries – financial market

Uncertainties about fiscal policy in the Luiz Inácio Lula da Silva (PT, progressive-globalist) government give room for the maintenance of monetary tightening for a longer period of time, which would lead to a smaller reduction in the basic interest rate (Selic) in 2023.

This is the interpretation of the financial market: in the last four weeks, the median of expectations for the Selic at the end of next year rose from 11.25% to 11.75%, according to the Focus bulletin of the Central Bank.

The trend for the Monetary Policy Committee (Copom) meeting that ends this Wednesday (Dec. 7), according to the vast majority of financial market economists, is to maintain the rate at the current level of 13.75%.

For Bradesco’s economic team, the decision should be accompanied by signs of “the future maintenance of this level for an extended period”.

Itaú points out that considering the high level of uncertainty, particularly in relation to the trajectory of public accounts, the expectation is that the committee will reinforce the signal to maintain the “vigilant posture of monetary policy”.

The bank’s economic department believes that the Central Bank will not hesitate to resume the adjustment cycle – i.e., raising interest rates – if the process of reducing inflation does not run its course as expected or if inflation expectations weaken.

“The Central Bank will maintain its posture of addressing the importance and its attention to inflation control, demonstrating its attention to the macroeconomic scenario, and, mainly, the relevance in fiscal decision making,” points out Jaqueline Benevides, fixed income analyst at the financial platform TC.

SELIC RATE CUTS WILL DEPEND ON GOOD FISCAL CHOICES

Itaú sees cuts in the Selic rate only in the third quarter of 2023, conditioned to good choices in the fiscal area, and even then, not intensely.

“The unfolding of the Transition PEC, the financial risk, and the uncertainties about the economic guidelines generate uncertainty in the market,” says the chief economist at Suno Research, Gustavo Sung.

The PEC, which has a Senate vote scheduled for this Wednesday, removes Bolsa Família and other expenses from the spending cap, the country’s main fiscal anchor.

According to the text approved by the Constitution and Justice Commission (CCJ) on Tuesday (Dec. 6), the extra-ceiling amount fell from R$175 (US$33) billion to R$145 billion per year after an agreement between the government and the opposition.

And the validity period, which was initially for an indefinite period, went to two years.

Itaú estimates that a waiver (license to spend beyond the ceiling) of R$96 billion (or 0.9% of Gross Domestic Product) would leave primary federal spending at 18.4% of GDP in 2023, the same level projected by the government for 2022.

According to the financial institution, this value would be more than enough to finance the main campaign promises.

Among them are the maintenance of the Brazil Aid at R$600, the additional R$150 for families with children up to 6 years old, the real increase of the minimum wage by 1.4% above inflation, and the Popular Pharmacy program and other health expenses.

“An increase in spending without compensation can generate a substantial increase in the public debt and harm society as a whole. Fiscal balance is not incompatible with social responsibility – on the contrary, it is a necessary condition for sustainable social gains,” the bank’s economists quote.

THE UNFOLDING OF THE PEC AND THE NEW FISCAL FRAMEWORK CAN AFFECT INTEREST RATES

According to Sung, the big problem that can change the scenario for the Selic rate is the unfolding of the PEC and the discussion about a new fiscal framework.

According to him, a fiscal policy of more spending can affect the control of interest rates in two dimensions.

in the short term, such policy affects the mood of the market, positively influences economic activity, and raises inflation expectations; in the long term, it reduces the credibility of the country’s fiscal framework.

“An eye on the fiscal balance is necessary for the monetary authority not to take a more timely attitude. With the deterioration of the scenario, especially the inflationary one, the Central Bank will have to raise interest rates to meet its objective of bringing inflation around the target,” cites the chief economist.

The absence of a substitute for the spending cap, which Lula intends to abolish, also worries the market.

“We don’t know which instrument the elected government will propose so far and how this substitution will impact the fiscal accounts.”

“In short, the fiscal scenario is not so clear throughout the new administration.”

“Again, our best guess is that the elected government may adopt a prudent approach with a solution that does not compromise the prospects for public debt sustainability,” point out economists from MUFG Brasil bank.

In the negotiations to approve the text of the PEC in the Senate’s CCJ on Tuesday, the government pledged to present to Congress within eight months a proposal for a new fiscal regime to replace the spending cap.

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