The central bank kept the benchmark interest rate (7-day repo rate) unchanged at 40% at its second monetary policy meeting in May. The monetary authority maintained an unusual wide corridor, with the lending rate at 47% and the borrowing rate at 33%, which it expects to normalize when market instability moderates.
The central bank expects core inflation to remain at high levels in May, given its high-frequency indicators (2.1% mom in April). In particular, the monetary authority expects the depreciation of the peso to keep consumer prices under pressure in the near term. As inflation remains higher than that projected for the rest of 2018 and given instability in emerging markets, real interest rates in the near future will continue significantly higher in the past. While our current forecast for the reference rate stands at 30% by December, we don’t expect changes in the next meetings.
On a separate note, the EMAE (official monthly GDP proxy) surprised expectations to the downside in March. Activity expanded 1.4% yoy in March (down from 2.8% and 3.3% expected by the market and us, respectively). On a sequential basis, the economy fell by 0.1% mom/sa, following a 0.2% loss in February. January activity was upwardly revised to 0.9% from 0.7% previously leaving to a still strong quarter-over-quarter expansion of 4.3% (annualized). The EMAE expanded 3.5% yoy in 1Q18, down from 4% in 4Q17.
We expect the economy to continue to decelerate markedly in the coming months. The impact of the drought will be harsher in 2Q18 while tighter macro policies and lower real wages will hinder domestic demand. The international environment (Brazil’s growth and financial conditions) is also less supportive. We see downside risks to our GDP growth forecast of 2.0% this year.
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Day Ahead: The trade balance for April will come out at 4:00 PM (SP Time). We expect a trade balance close to zero (consensus: – USD 139 million). If our forecast is correct, the rolling 12-month trade deficit will decrease to USD 9.7 billion from USD 9.8 billion in March.
According to the Copom minutes, the latest indicators outline a slowdown in an environment of consistent, albeit gradual, recovery in economic activity. The economy continues to run with high levels of slack in production factors, reflecting low industrial capacity utilization and, especially, unemployment. The external environment is now regarded as challenging, as the evolution of risks associated with interest rate normalization in some advanced economies led to adjustments in financial markets and sparked volatility. Consequently, risk appetite for emerging market economies decreased. The Copom understands that inflation continues to behave favorably, with several underlying inflation measures remaining at low levels, including those components that are more sensitive to the economic cycle and monetary policy.
The committee signaled that it would be adequate to maintain the Selic stable at 6.5% in upcoming meetings, given the current balance of risks and inflation forecasts that the monetary authority regards as comfortable. Furthermore, the Copom noted that the extent of pass-through of recent FX depreciation depends on many factors, such as economic slack and how anchored inflation expectations are. Thus, the behavior of different measures of FX pass-through will weigh on upcoming decisions, as they will allow an assessment of the impact of FX fluctuations on price levels and whether monetary policy actions are needed to fight its secondary effects. In our baseline scenario, the Selic rate will remain stable at 6.5% until year-end, but the monetary policy stance will still depend on FX dynamics and, in special, its impact on inflation readings and inflation expectations, particularly for 2019.
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Day Ahead: May’s IPCA-15 inflation will be released at 9:00 AM (SP Time). We forecast a 0.27% monthly increase (consensus: 0.26%), with the 12-month reading at 2.83% (consensus: 2.82%). The Central Bank announced another FX swap rollover auction of up to 15,000 contracts.
After a sharp slowdown in 2017 (to annual growth of 1.3%, from 8.7% in 2016) – when the doubling of inflation (to 6.8%, from 3.4%) eroded real wages – retail sales rebounded in 1Q18, driven by a more dynamic real wage bill. Retail sales surprised to the upside, by expanding 1.2% year-over-year in March, above our forecast (-1.5%) and median market expectations (0.1%, as per Bloomberg). According to calendar-adjusted data reported by the statistics institute (INEGI), growth was higher (3.5% year-over-year) – netting out the negative effect of the Easter holidays (i.e.: less business days) – with growth of 1.4% year-over-year in 1Q18 (from a 1.1% contraction in 4Q17). This result actually put an end to a trend of four consecutive quarters of (calendar-adjusted year-over-year) deceleration.
We believe that the annual growth rate of retail sales will increase in 2018 (compared to the previous year). The factors supporting retail sales are robust formal employment – which has grown at an average pace of 4.4% year-over-year in the first four months of 2018 (from an average of 4.3% in 2017) amid positive economic activity surprises – and the substantial fall of inflation (which has translated into growing real wages, after four consecutive quarters of contraction). On the negative side, however, consumer confidence has weakened year-to-date (although there was some improvement in April) and remittances converted into pesos are less supportive (because of MXN appreciation) although they remain growing robustly in USD terms (and the recent weakening of the MXN will provide a boost).
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Day Ahead: The statistics institute (INEGI) will publish March’s monthly GDP proxy (IGAE) at 10:00 AM (SP Time), which we expect to contract 1% year-over-year (consensus: 0.46% contraction). Together with IGAE, INEGI will publish Q1’s GDP growth, which we expect to post 1.2% year-over-year (consensus: 1.40%).