Central Bank gives Lula a new message about spending

the Central Bank’s Monetary Policy Committee (Copom) sends a harsh message to the federal government about the need to control public spending. The message was passed on this Tuesday (12), with the release of the minutes of the Copom meeting held last week, which ended with a 0.5 percentage point increase in the basic interest rate (Selic).

According to the agency, controlling government expenses is essential to bring inflation back to the center of the target, which is 3% in 12 months, according to the National Monetary Council (CMN), and to reduce the risk on assets Brazilian financial institutions.

BC directors assess that the increase in public spending and the lack of predictability in fiscal rules affect asset prices and inflation expectations, requiring fiscal discipline for the sustainability of monetary policy. They also point out that the continued deterioration of expectations could lead to an extension of the cycle of rising interest rates.

The deterioration in expectations has been deepening since the beginning of the year. The financial market signal for the was 3.9%. At the beginning of this week it was at 4.62%, the sixth consecutive week of increase and the third in which it appears above the target.

One of the factors that help in the increasing deepening between inflation expectations and the target is the situation of public accounts.

Since June 2023, there has been a primary deficit (government expenditure, excluding interest on public debt, minus revenue) accumulated over 12 months in the consolidated public sector. Public debt has increased by almost seven percentage points since the beginning of the Lula government, in January 2023. In September it was 78.27% of GDP, according to the BC.

“A credible fiscal policy, based on predictable rules and transparency in its results, together with the pursuit of fiscal strategies that signal and reinforce the commitment to the fiscal framework in the coming years are important elements for anchoring inflation expectations and for reduction in risk premiums for financial assets, consequently impacting monetary policy”, says an excerpt from the Copom minutes.

The continuity of the policy of increasing public spending, the weakening of the effort towards structural reforms and fiscal discipline, the increase in credit directed to specific sectors and the uncertainties about the stabilization of public debt contribute to raising the economy’s neutral interest rate (that which neither stimulates nor slows down the economy).

It is a scenario that ends up forcing the Central Bank to place more emphasis on monetary policy and affecting the cost of reducing inflation in terms of economic activity.

Government spending helps to overheat the economy

One of the effects of greater laxity in relation to fiscal issues is the overheating of the Brazilian economy and the dynamism of the domestic labor market. The financial market signals that GDP will grow 3.1% this year.

Although the BC points out that some indicators show incipient signs of moderation, such as trade and income, it is not possible to conclude that this is a rate of inflection in economic activity.

The Copom highlights that it will continue to monitor the dynamics of economic activity, as the pace of growth helps make it more challenging to bring inflation closer to the target set by the CMN. For the fourth year in a row, the Brazilian economy is expected to grow at a rate close to or greater than 3%.

“The combination of a robust labor market, expansionary fiscal policy and vigor in granting credit to families continues to indicate support for consumption and consequently for aggregate demand”, points out the minutes.

Copom minutes show that the job market puts pressure on service prices

One concern of the committee regarding the dynamism of the labor market is the real gains (above inflation) in salaries in recent months. Data from the Salariometer project, from the Fundação Instituto de Pesquisas Econômicas (Fipe), show that in the 12 months ending in September there was a median real adjustment of 1.3% in salaries.

“As there is no evidence of a significant increase in productivity, such gains may reflect pressure in the labor market”, highlights the BC document. Some areas would already be experiencing labor supply problems.

The directors of the monetary authority emphasize that real wage growth, if persistent and above productivity gains, could be reflected in higher inflation.

Another reflection is that a stronger job market helps to influence an increase in the price of services, due to greater consumption. The institution’s directors emphasize that inflation in this sector remains above the target level. The combination of factors has decisive importance in the prices of Brazilian assets.

Brazilian asset prices are showing greater volatility and risk since the Copom meeting at the end of September. The monetary authority assesses that there are uncertainties in both the internal and external scenarios. “A scenario of greater global uncertainty and more abrupt movements requires greater caution in the conduct of domestic monetary policy”, highlights the document.

Uncertainties are also evident abroad

The monetary authority assesses that there are also uncertainties abroad. “A scenario of greater global uncertainty and more abrupt movements requires greater caution in the conduct of domestic monetary policy”, highlights the document. The BC’s assessment is that there are relevant economic and geopolitical uncertainties, especially in the United States and China.

Doubts about the pace of disinflation and the slowdown in economic activity in the USA, in addition to the possibility of changes in the country’s economic policy, generate uncertainty. China faces a slowdown, but its recent fiscal and monetary measures may bring some support to near-term growth.