BRASILIA (Reuters) - Seven months into the presidency of Roberto Campos Neto, Brazil’s central bank has implemented a quiet revolution in its monetary policy, with the former trader showing a willingness to tolerate a weaker currency.
In selling international reserves for the first time in 10 years to meet demand for dollars, while slashing interest rates to new lows to revive growth, the blue water between monetary and exchange rate policy is becoming ever clearer, analysts say.
In some ways, the central bank’s bold action on rates is unsurprising: the economy flirted with recession and is struggling to grow, inflation is well below target, the government has made clear fiscal support is off limits, and central banks around the world are easing aggressively too.
The big difference now, according to observers, is that the bank’s policy-making committee known as ‘Copom’ under Campos Neto’s guidance is far less concerned with the spillover effect on the exchange rate.
As long as the so-called ‘pass through’ to inflation from a weakening currency is limited, it can reduce the benchmark Selic to spur growth and inflation, while any unwanted currency depreciation or volatility can be met with direct intervention via the sale of dollars.
“They are under pressure to deliver growth. I don’t think there’s a policy to weaken the currency explicitly, but if the exchange rate keeps weakening without causing inflation, they will tolerate it,” said one former colleague.
“They are seeing interest rates and FX separately. It’s a new approach. I don’t like it much,” he said.
The central bank’s actions and statements since it cut the Selic rate by half a percentage point to a then low of 6.00% on July 31, and markets’ reaction to them, are instructive.
The real lost 8% of its value in August, its biggest monthly fall in four years, and market-based interest rates steadily fell to fresh lows as Campos Neto repeatedly said “benign” inflation allowed for “further adjustments” in policy.
The statement accompanying last week’s rate cut to 5.00% was even more dovish than analysts had expected, prompting another sell-off in the currency and steep decline in implied interest rates. Several economists slashed their forecasts, with French bank BNP Paribas going as low as 4.25% by February next year.
Yet inflation expectations are well-anchored. Even Copom’s “hybrid” model based on the market’s consensus Selic forecast and the current exchange rate - that is, the lowest available levels for both - showed inflation next year at 3.80%, below the bank’s official target of 4.00%.
This is encouraging policymakers to keep their foot on the easing pedal.
(Graphic: Brazil interest rate vs inflation, here)
Not everyone agrees that there is a major policy shift under way. But a consensus is forming that a mix of low growth and inflation calls for more rate cuts, while dollar outflows from Brazilian companies paying down foreign debt and large FX reserves open up the potential for FX intervention.
Especially with a market-savvy former trader at the helm.
“He was a trader, a treasurer, and a banker, so maybe that makes him more at ease pursuing these kind of interventions. In a way though, it’s not a major shift, but perhaps a new way of intervening that reflects a new reality,” said Carlos Kawall, chief economist at Banco Safra in Sao Paulo.
Campos Neto earlier this month defended the landmark decision in August to sell dollars on the spot currency market for the first time since 2009, and indicated it may not be the last time.
“Foreign exchange interventions act as a mechanism of stability in the foreign exchange market,” he said.
A central bank spokesman declined to comment for this article.
(Graphic: Brazil FX reserves vs dollar/real, tmsnrt.rs/2mzilZV)
One former central bank director said this separation between monetary and exchange rate policies already existed, but the move to sell international dollar reserves outright marked a “significant” change from the previous administration.
Previously, pockets of illiquidity or dollar demand mismatches would tend to appear in the derivatives markets, so the central bank would intervene with currency swap or credit lines operations.
Now, the shortage of dollars is manifesting itself in the spot market, which is where the central bank has acted for the first time since February 2009. Crucially, as Campos Neto has indicated, last month’s sale of just under $4 billion may not be the last.
Alexandre Schwartsman, director of international affairs at the central bank from 2003 to 2006, doesn’t buy into the idea that there’s much of a shift under way at all. But he recognizes that market and economic conditions are such that different policy actions can now be considered.
Central to this are inflation and inflation expectations, both of which are firmly anchored despite the weakening exchange rate. As long as this remains the case, the central bank can continue lowering rates and chipping away at its mountain of FX reserves.
“The central bank will intervene when it thinks there is a lack of liquidity in the market,” Schwartsman said. “Brazil has $380 billion of reserves, I’m pretty sure we can afford to use some of that to ease the liquidity problem, even if only in a small way it helps reduce public debt.”
Reporting by Jamie McGeever; Additional reporting by Marcela Ayres; Editing by Nick Zieminski