The Brazilian central bank must use its formal monetary policy framework to explain how it will balance the competing priorities of growth, inflation and the exchange as it shifts away from pure inflation targeting, analysts have said.
Last week the Banco Central do Brasil (BCB) wrong-footed financial markets with a larger-than-expected 75 basis points (bp) cut in the Selic policy rate to 9.75%, taking borrowing costs to a two-year low.
In an exclusive interview with Emerging Markets published yesterday central bank chief Alexandre Tombini said the prolonged global economic slowdown had “opened up space for adjusting policies”.
Analysts said the BCB’s de facto shift away from pure inflation-targeting to multiple targets – growth, inflation and the exchange rate – should be formally acknowledged to avoid undermining market confidence over the stability of monetary policymaking in Latin America’s largest economy.
“The change in the Brazilian central bank’s monetary policy framework over the past year needs to be codified and more publically communicated else uncertainty in the market will be entrenched,” Tony Volpon, senior Latin America economist at Nomura, told Emerging Markets.
After raising rates in the first half of last year to arrest inflationary pressures, the central bank surprised markets and slashed rates by 50bp in August, kicking off an easing cycle to boost lacklustre growth despite inflation in November touching the upper bound of the central bank’s 6.5% target.
Volpon argued that the bank was effectively targeting inflation of 5.5%, rather than the official target of 4.5% with a range of plus or minus two percentage points.
The BCB has accommodated rising price pressures in the services sector - which adds 1% to the headline inflation rate - in order to boost growth, said Volpon.
“If the central bank doesn’t come clean about its new inflation target it risks its credibility, as it is failing to make inflation converge to its 4.5% target year after year, and creates great dispersion in inflationary expectations.”
The economist, who was one of the few strategists to correctly predict the 75bp cut, added: “Market uncertainty over the stability of monetary policy in Brazil will be reflected in rising risk premia, the forward interest rate curve and sovereign credit spreads, which will all impact Brazilian growth.”
Eduardo Levy Yeyati, economics professor at Universidad Torcuato Dei Tella said the central bank needed to be more explicit about its commitment to stabilize the exchange rate, possibly by incorporating currency objectives in its formal monetary policy framework.
“At present, it looks like they are improvizing,” he told Emerging Markets. “It’s high time for the central bank to issue an explicit wording of its policy to stabilise exchange rate expectations.”
Claudio Irigoyen, strategist at Bank of America Merrill Lynch, said the monetary authority should tolerate greater currency volatility and introduce “greater randomness” in its currency intervention approach to outwit foreign investors.
Although analysts support the direction of monetary policy-making, greater clarity over the relative importance of growth, inflation and the exchange rate in its formal mandate would help stabilize market expectations, they added.