Brazil Central Bank Sees More Restrictive Monetary Policy After Split Vote on Rates

(Bloomberg) -- Brazil’s central bank said it unanimously sees more restrictive interest rates ahead as the institution tries to calm investors following a split policy decision that exposed rifts among its board members.

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“In the end, it was unanimously concluded that a more contractionary and more cautious monetary policy was needed,” central bankers wrote in minutes to their May 7-8 rate decision, when they cut the benchmark Selic rate by a quarter-point to 10.5%. Still, all four board members appointed by President Luiz Inacio Lula da Silva backed a larger, half-point drop at the meeting.

Central bankers disagreed on the costs of scrapping previous guidance that had signaled a half-point rate cut, according to the minutes published Tuesday.

A majority argued a change of pace was needed in light of worsening inflation estimates, a stronger-than-expected economy and a more adverse global outlook. A minority, including directors Gabriel Galipolo and Paulo Picchetti, disagreed by saying another half-point drop would keep policy “sufficiently contractionary,” while also worrying about hurting the bank’s official communication.

“Much more important than the possible reputational cost of not following some guidance, even if conditional, is the risk of loss of credibility about the commitment to fighting inflation,” wrote the majority, led by Governor Roberto Campos Neto. All members agreed on giving no guidance for their next rate decision in June.

What Bloomberg Economics Says:

The minutes of the Brazilian central bank’s May meeting show policymakers don’t disagree on the broader rate outlook, but there are differences on how to signal their commitment to the inflation target. The document was more hawkish than the post-meeting statement and, with inflation expectations likely to deteriorate, we see upside risks to our year-end rate forecast of 9.5%.

— Adriana Dupita, Brazil and Argentina economist

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Brazil’s split decision fueled speculation about the board becoming more permissive on prices going forward. Swap rates rose and the real led losses among major currencies after last week’s announcement. Traders are now split on whether policymakers will deliver one more cut in June or pause their monetary easing, while analysts have lifted their year-end borrowing cost bets.

Read More: Brazil Analysts Lift Rate Bets as Central Bank Splits on Policy

The minutes showed agreement among board members in key issues such as inflation estimates and an adverse global environment, said Paulo Gala, an economist at Fundacao Getulio Vargas. “Still, there’s a difference in visions that should appear again in the future, and it could happen at the end of the cycle.”

Fiscal Policy

Investors see odds of a shift in the bank’s views on inflation once Lula appoints two directors as well as the institution’s new governor by the end of the year. In private settings, some of his four current appointees to the board have appeared more willing to tolerate higher consumer price estimates, which have remained steady above the 3% target for almost a year.

Read More: Under Lula, Doves Are Rapidly Gaining Power in the Central Bank

In minutes to their rate decision, board members said uncertainties on Brazil’s fiscal path could have worsened inflation estimates, noting there has been an increase in the country’s risk premium. They said they are “closely” following the impact of spending on monetary policy.

A more challenging global scenario and a perception that the monetary authority will become more lenient toward prices might also be at play, they wrote.

“The Committee will not shy away from its commitment of reaching the inflation target,” they wrote. The board “unanimously” agreed on the importance of pursuing their consumer price goal.

“The explanation on their divergences doesn’t appear to be enough to reduce the increasing uncertainties in financial markets,” said Leonardo Costa, an economist at ASA Investments, said in a written response, citing continued risks the board turns softer on inflation once Lula has nominated a majority of its members.

Brazil’s annual inflation slowed for the seventh straight month in April to 3.69% in a report encompassing a period before devastating floods in the nation’s south. Tuesday’s minutes showed some members of the board are more concerned about food prices, and the bank recognized heavy rains will hurt the economy.

(Recasts with more details from minutes and economist comments throughout)

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