MercoPress. South Atlantic News Agency

Brazil's Central Bank increases Selic rate above expectations

The council of experts mentions an “underlying inflation”

Brazil's Central Bank (BCB) Monetary Policy Committee (Copom) decided once again Wednesday to increase the basic Selic interest rate from 6.25% to 7.75% annually, in what turned out to be the sharpest rise since December 2002, it was announced.

The new index also meant an end to the sequence of 1% increases decided in the two previous meetings. It also leaves the Selic at its highest level since September 2017, when it reached 8.25%.

Until a few weeks ago, analysts were expecting yet another 1% raise, but expectations were revised after the fiscal risk went up with the federal government and Congressional efforts to pierce the spending ceiling rules, which was read negatively in financial markets, pushing up the US dollar to its highest levels in six months against the real.

At the same time, the Ibovespa Brazilian Stock Exchange index dropped to its worst score in almost a year.

The Brazilian government needs to increase spending to finance social aid to counter an increasing economic crisis stemming from COVID-19 restrictions.

The Selic trajectory is expected to remain upward in the next Copom meetings and close 2021 at 8.75%, according to the Focus Bulletin published earlier this week. By 2022 it is expected to reach 9.50% due to the increase in borrowing and the retraction of investments. Copom members convene every 45 days. Their next encounter -the last one in 2021- is scheduled for Dec. 7 and 8.

The latest Copom assessment points out signs of persistent inflation in addition to “volatile” components, while greater inflation is to be foreseen amid growing spending. With the release of the October inflation preview, which indicated an acceleration of price increases, economists had already revised the projection to 7.75% confirmed by the Copom report which also mentions an “underlying inflation,” which is more lasting.

Economy Minister Paulo Guedes has said that the changes in the spending ceiling are aimed at expanding social protection through Auxílio Brasil, President Jair Bolsonaro's social program which replaces the Bolsa Família created under previous administrations.

Analysts have insisted social assistance could be increased without exceeding the expenditure limit through reassignment of funds from other areas where costs could be reduced.

The Central Bank's main instrument to contain the spread of price increases is the basic interest rate, which is defined based on the inflation targeting system. Normally, when inflation is high, the BCB raises the Selic and reduces it when inflation estimates are in line with predetermined targets. For 2021, the central inflation target is 3.75%. According to the system in force in the country, it will be considered fulfilled if it is between 2.25% and 5.25%. Next year, the central inflation target is 3.50% and will be officially met if the index fluctuates from 2% to 5%.

In September, the Extended National Consumer Price Index (IPCA), considered the country's official inflation, was 1.16%. This was the highest rate for one month of August since the beginning of the real plan, in 1994. In 12 months, inflation reached the double-digit level: 10.25%, the highest since February 2016.

According to a survey by the Higher Institute of Administration and Economics of the Getúlio Vargas Foundation (ISAE/FGV), more than half of inflation this year is the result of the increase in fuel, energy and meat.

Under the present conditions, Brazil seems headed for “stagflation” - stagnation of the economy, that is, without growth in the level of activity, or even retraction, associated with rising unemployment and inflation. In that scenario, President Jair Bolsonaro's chances of being reelected seem to be shrinking permanently.