Cut of 0.5 Percentage Points Surprises Experts. Now, Interest Rate Projections for the End of 2023 May Be Revised
By Luíza Lanza
08/02/2023
The Monetary Policy Committee (Copom) decided on Wednesday (August 2) to cut Brazil’s benchmark interest rate, the Selic, by 0.5 percentage points.
After remaining stagnant at 13.75% per year for a year, the country’s interest rate is now reduced to 13.25% per year.
The decision was more optimistic than expected and is likely to lead to revisions of Selic projections for the end of 2023 and increased investments.
This marks the first interest rate cut in Brazil in three years, widely anticipated as a turning point from the monetary tightening initiated in 2021 to a new easing cycle.
Although the drop was unanimous, the magnitude of the cut had been debated by investors, analysts, fund managers, and economists up to the eve of the meeting without a clear consensus. Opinions ranged between a modest 0.25 p.p. cut and a more aggressive 0.5 p.p. adjustment.
Within Copom, the decision was also split: 5 to 4 in favor of the announced 0.5 p.p. cut. Of particular note was Central Bank President Roberto Campos Neto’s support for the more aggressive reduction, along with directors Gabriel Galípolo and Ailton Aquino—both newcomers to the committee and appointed by the Lula administration.
“The fact that RCN and Galípolo voted together prevents internal conflicts within the Central Bank’s board in the conduct of monetary policy and eases pressure on the Central Bank,” emphasized economist André Perfeito.
For future meetings, the Central Bank’s statement indicated that the pace of cuts is likely to remain at 0.5 p.p. Consequently, some market participants are revising their Selic projections for the end of 2023 to 11.75%, lower than the Focus Bulletin’s estimate of 12%.
The news is positive for the investment market, especially for risk assets that suffered greatly during the interest rate hike cycle. Many Brazilian stocks, real estate funds, and investment funds had already been recovering in recent months as investors anticipated the rate cut in this August meeting. However, specialists see room for further gains now that the adjustment has been confirmed.
“The decision was positively received by the market. Therefore, assets more sensitive to interest rates should see a very positive impact in the coming days,” highlighted Lucas Martins, partner and specialist at Blue3 Investimentos. “The market will show on Thursday (August 3) if there will be a more significant drop in future interest rates compared to earlier this year, which would be very positive for risk assets like stocks and real estate funds.”
Market Reactions
Daniel Wainstein, senior partner at Seneca Evercore and former Goldman Sachs Brazil executive:
“The cut was slightly above market expectations but aligns well with our outlook. Brazil’s risk has significantly declined—literally half of what it was on October 31, 2022, during the elections. There is no clear inflationary pressure, and real interest rates of 10% based on expected inflation are clearly too high.
What does this mean for the real economy? Banks can borrow money at lower rates, but if the spread (the difference between the rate charged to clients and the rate paid by banks) doesn’t decrease, it will not benefit consumers or our clients—the Brazilian entrepreneurs.
The basic rate cut, combined with a lower return demanded by investors, should increase the value of Brazilian companies. Partly, the recent rise in the Bovespa index reflects investors’ belief that cuts were coming. There is undoubtedly room for further significant reductions in the near future.”
André Perfeito, Economist
“What interests us at this moment is the statement, which included some important points. Despite the split decision, Roberto Campos Neto and Galípolo voted together for the cut, signaling that the rate should remain in the contractionary zone to anchor expectations.
This suggests that the ‘shot will be short,’ meaning the final easing of the Selic rate may be larger than the market expects. The cycle will likely end early next year, with the Selic rate at 10.75%, which should still be considered contractionary.
The fact that RCN and Galípolo voted together avoids internal conflicts within the BCB board in conducting monetary policy and eases pressure on the Central Bank.
The market is likely to revise its Selic expectations for the end of 2023 to 11.75%, aligning with our projections.”
Felipe Moura, Partner and Analyst at Finacap Investimentos
“The rate cut was larger than what most of the market expected, which was 0.25%. Also noteworthy is the comment in the statement that the Central Bank foresees cuts of the same magnitude, essentially defining 50 basis points as the appropriate pace for upcoming reductions.
This was very positive, and the market should continue reacting well, especially since the stock exchange has remained above 120,000 points for over a month. Although the market had partially priced this in, the effect should still positively impact equities. Another key point is that we have officially entered the interest rate cut cycle in Brazil. Historically, in previous monetary easing cycles, we see that the Ibovespa tends to perform positively, on average, from the beginning to the end of the rate cuts.”
Ricardo Jorge, Fixed Income Specialist and Partner at Quantzed
“One of the most important points is that the committee highlighted the existence of a deflationary environment, which was one of the reasons for the decision. We’re seeing disinflation on the margin, but even so, the Central Bank emphasized its commitment to bringing inflation closer to the target, signaling a contractionary policy for a longer period. This indicates there is currently no room to accelerate the cuts further, meaning we’ll likely continue at this pace of 0.50.
An important message was the removal of the statement mentioning fiscal risk and the risk of de-anchoring expectations. This is significant and somewhat controversial, as the Central Bank no longer considers fiscal risks in a scenario where several issues are still pending in Congress.”
João Savignon, Head of Macroeconomic Research at Kínitro
“Despite a more dovish decision than expected, it’s worth noting that the vote was divided, with a 5×4 decision for the 0.5 percentage point cut. The new directors voted for the more significant cut, as expected, and were followed by the Central Bank president, Roberto Campos, and two other directors, Carolina Barros and Otávio Damasio.
We believe the Copom will maintain this pace of rate cuts in upcoming meetings but don’t rule out an acceleration if the scenario evolves favorably. For instance, if domestic risks remain low, economic reforms advance in Congress after the recess, there are new indications of a sovereign rating upgrade leading to currency appreciation, or further declines in inflation expectations and core inflation sensitive to the economic cycle.”
Raphael Vieira, Co-Head of Investments at Arton Advisors
“The Copom maintained its stance on contractionary monetary policy and monitoring data affecting inflation and economic activity. Despite starting with a 0.50 cut in a non-unanimous decision, the committee stressed it could reassess the magnitude of cuts in future meetings if inflationary pressures worsen.
The market was somewhat divided between a 0.25 or 0.50 cut, with the yield curve pricing a higher probability of 0.25. With the decision at 0.50, the curve will likely be repriced, and expectations adjusted to the tone of the statement.”
Bruno Monsanto, Investment Advisor and Partner at RJ+ Investimentos
“A 50 basis points cut was expected by a smaller portion of the market; it wasn’t a consensus, so it was a positive surprise. As a result, risk assets are expected to gain good traction, fixed-income assets will likely see a greater impact on offered rates starting tomorrow, and there will likely be some relief in the private credit market. This should also result in less political noise, fewer government criticisms of the Central Bank, and a more harmonious climate between the Central Bank and the government.”
André Meirelles, Director of Allocation and Distribution at InvestSmart XP
“The Copom decided to reduce the Selic rate by 0.5%. The cut was larger than economists expected but aligned with market expectations when considering the interest rate yield curve.
In its statement, the Copom forecasted another 0.5% cut for the next meeting. Notably, Central Bank President Roberto Campos Neto voted in harmony with the new Copom members, Gabriel Galípolo and Ailton de Aquino Santos, the only two appointed by the current government.
For upcoming decisions, the Copom will likely weigh the risks outlined in its risk assessment: persistent global and domestic inflation in services could lead to smaller cuts, while sharper global economic slowdowns or inflation surprises to the downside could prompt larger cuts, such as 0.75%.
So far, the Copom is expected to maintain this pace. For risk assets, this decision could be seen as positive.”
Lucas Martins, Partner and Specialist at Blue3 Investimentos
“The 0.5 p.p. cut was anticipated by part of the market, though most expected a more conservative stance from the Central Bank for this first cut. In its official statement, the committee noted that, despite the recent easing in inflation, inflation projections remain elevated. Considering inflationary risks and recent improvements in domestic inflation and other economic indicators in the first half of the year, the Copom decided, by a 5–4 vote, to begin a gradual monetary easing cycle.
The decision was positively received by the market, which also expects a similar cut in the final meeting of the year, closing 2023 with the Selic rate at 12%. Consequently, interest rate-sensitive assets should experience a very positive impact in the coming days. The market will likely show on Thursday whether there will be a more significant drop in future interest rates compared to earlier this year, which should benefit risk assets like stocks and real estate funds.”
Adriana Dupita, Senior Economist for Brazil and Argentina at Bloomberg Economics
“Lower-than-expected underlying inflation, coupled with reduced political uncertainty, led the Central Bank of Brazil to begin easing its ultra-tight monetary policy. As we anticipated, the decision was not unanimous, and policymakers carefully framed their language to temper expectations for larger cuts in future meetings. We revised our year-end rate forecast slightly to 11.75%.
This move raised the real ex-ante rate — adjusted for expected 12-month inflation — to 8.8%. This remains significantly above the Central Bank’s assumed neutral rate of 4.5%, indicating that monetary policy remains very restrictive.
We expect half-point cuts at each of the three remaining meetings this year.”
Nicolas Borsoi, Chief Economist at Nova Futura
“The Copom described the external environment as uncertain, noting that while disinflation continues, core inflation remains high and labor markets in several countries remain resilient, suggesting a less favorable outlook for global disinflation despite the commitment of central banks to achieving inflation targets.
Domestically, the Copom acknowledged the economic slowdown and the decline in core inflation, despite its elevated level.
In our view, the Copom’s decision aims to recalibrate the restrictive stance of monetary policy after the recent drop in inflation amplified the contractionary effect of high domestic interest rates. However, the statement that 0.5% is the appropriate pace, with the September 2023 decision dependent on upcoming data, suggests a 0.75% cut is possible.
Preliminarily, we maintain our projections of three 0.50% cuts through December 2023, ending the year with the Selic rate at 11.75%, but acknowledge a downside bias.
Furthermore, the Copom’s choice to leave the magnitude of the easing cycle open suggests the market may test a terminal Selic rate below 9.0% in the coming days, although this is not our base scenario.”
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