At the last meeting of the year, the Banco Central the rate should rise again Selic and, this time, everything indicates that it will be in an even stronger dose. Most economists believe that the Selic will rise by 0.75 points, to 12% per year. An even stronger increase, of 1 percentage point, is not ruled out.
But what is worrying experts is that the increase in interest rates made so far is not having the expected effect: inflation remains high and, worse, expectations are increasingly negative. This is what experts call loss of effectiveness of monetary policy. In this type of situation, to achieve the same result, the dose of interest needs to be much higher.
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The Selic has been in double digits since February 2022. If this majority bet is confirmed, the BC will be accelerating the pace: in the previous meeting, the interest rate had risen 0.5 points, to the current 11.25%.
An increase of 0.75 points is not trivial, especially when the rate has already reached such a high level. The chief economist of Bradesco, Fernando Honoratoremember that this dosage was used in only 13% of interest rate hike cycles.
“An acceleration of the pace will not solve the problems that brought us here. At this point, there is nothing the Central Bank can do to prevent inflation in the coming months from being pressured by exchange rate pass-through, rising protein prices and deteriorating expectations.”
Fernando Honorato, chief economist at Bradesco
Uncertainty about the fiscal framework will continue to compromise investor confidence. And that is why, for the Bradesco economist, there would be no point in the BC accelerating its pace now: the best thing would be to continue at the current pace, of 0.5 points.
While Brazil is moving towards accelerating its pace, most BCs are going against the trend, reducing interest rates. This should be having an effect on both inflation and the exchange rate. After all, the difference between Brazilian interest rates and those in the rest of the world should attract more foreign investment and, therefore, increase the value of the real. None of that is happening.
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In the scenario outlined by the chief economist of the Citi, Leonardo Portothe Selic will end the year at 12% and will continue to rise in 2025, until it reaches 13.25%. And Brazil would be the only country among the world’s main economies to raise interest rates next year – all others are expected to reduce their rates over the next year.
As a consequence, economic growth will lose strength. Porto expects a GDP increase of 3.3% this year, 2.2% in 2025 and 1.8% in 2026 – the worst performance among its peers.
However, even with interest rates weighing on the lives of companies and consumers, inflation here will remain above the target. Porto expects the IPCA to rise 4.8% this year and 4.3% next year. The target to be pursued in 2025 is 3%. This shows that the rise in interest rates is not fully fulfilling its role, largely due to the exchange rate imbalance — the strong depreciation of the real against the dollar ends up accentuating the price pass-through.
To be effective, monetary policy depends on what economists call “transmission channels”. The main ones are credit, exchange rate, asset prices and expectations. It is a complex pipeline that needs to be unblocked for interest to actually reach the real economy..
According to Porto, what is hindering this effect today is the expectations channel. And what makes it very clear that this pipeline is not working is the reaction of future interest rates to the Central Bank’s decisions.
In normal times, longer interest rates fall when the Central Bank accelerates the increase in the Selic, as it understands that inflation will fall and, thus, the BC will be able to provide some relief in monetary policy in the future. Now, the BC is raising the Selic higher, but interest rates are even higher, because investors doubt the effectiveness of the Selic.
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And what is blocking this pipeline, according to him, is an old acquaintance: the inspector. As there is a prospect of continued spending and worsening public debt conditions, the ability of interest rates to cool the economy and contain inflation is compromised. And then the Central Bank has to raise interest rates much more than would be necessary in another scenario.
The risk that some experts see is that the situation will worsen to such a point that, at some point, raising interest rates will end up having a more harmful effect than a benign one for the economy. Interest can no longer contain inflation and its only effect is to increase public debt. This is technically called fiscal dominance. We haven’t reached that point yet, but the risk is there, guarantees the economist.
“We are not in fiscal dominance, but that does not mean that monetary policy is not losing its effectiveness.”
Leonardo Porto, chief economist at citi
It is important to remember that Brazil has not experienced fiscal dominance since the Real Plan. But the topic is back on the agenda because the debt is rapidly deteriorating. In Citi’s scenario, public debt should end 2026 at an amount equivalent to 86% of GDP.
