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Brazil Cuts Interest Rate by Half-Point and Puts Smaller Reductions in Play

(Bloomberg) -- Brazil’s central bank lowered its interest rate by a half-point and pledged another cut of the same size for its next meeting only, opening the door to smaller drops starting in June amid underlying inflation pressure.

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The bank cut the benchmark Selic to 10.75% on Wednesday, as expected by all analysts in a Bloomberg survey and in line with prior guidance. In a statement, board members wrote measures of core inflation remain above target, reiterating that monetary policy requires “serenity and moderation.”

“Due to heightened uncertainty and the need for more flexibility in the conduct of monetary policy, the Committee members unanimously decided to communicate that, if the scenario evolves as expected, they anticipate a reduction of the same magnitude in the next meeting,” policymakers wrote.

Central bankers led by Roberto Campos Neto are gradually relaxing monetary policy after battling a post-pandemic price surge with the highest rates in six years. Annual inflation is at the top of the tolerance range, showing no signs of reaching the 3% target any time soon. Complicating matters are rising costs of food, as well as President Luiz Inacio Lula da Silva’s calls for more public spending in an economy that’s recently shown renewed signs of resilience.

“They have chosen to be ultra-cautious,” said Brendan McKenna, an emerging-markets economist and currency strategist at Wells Fargo. “A lot of uncertainty tied to the fiscal path and the evolution of government spending can influence whether to go 50bps, 25bps or even end easing altogether.”

The real strengthened 0.2% early Thursday, with many traders having already priced in chances of a more hawkish tone from the central bank. Swap rates on the contracts due in January 2025, which indicate market sentiment about monetary policy at the end of this year, rose five basis points.

Brazil’s decision came after the Federal Reserve left its borrowing costs unchanged for a fifth straight meeting and also maintained its outlook for three quarter-point rate cuts this year.

Caution

In the statement, Brazilian policymakers wrote that the global outlook remains volatile, with debates in many countries over how quickly inflation will slow. “The Committee judges that the environment continues to require caution from emerging market economies,” they wrote.

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“We think the more hawkish tone of the post-meeting statement and vagueness about the extent of the cycle will fuel market debate on the BCB’s terminal rate. The statement and forward guidance back our call for another 50-basis-point cut in May and smaller reductions starting in June. We see the policy rate down to 9% by year-end.”

— Adriana Dupita, Brazil and Argentina economist

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Board members reiterated that local interest rates will need to remain restrictive until the consumer price expectations anchor around target.

The central bank sees annual inflation at 3.5% in December and 3.2% at the end of next year, unchanged from their prior forecasts in January. Annual inflation is currently running at 4.5%.

Indeed, costs of staple goods including rice and beans are soaring, unnerving members of Lula’s administration who worry about the president’s ability to deliver on his campaign pledge to improve living standards for all Brazilians.

Investors are concerned the government could respond with even more spending, forcing policymakers to stop cutting rates sooner than expected and weakening Finance Minister Fernando Haddad’s push to strengthen public accounts. In the statement, central bankers reaffirmed the need of “firmly pursuing” established fiscal targets.

Autopilot

To be sure, policymakers gave no clear indication of how far they will lower borrowing costs. Some analysts pointed out the central bank could have the option of cutting rates by a half-point after May even if they didn’t explicitly commit to doing so now.

“The central bank is being cautious due to recent inflation trends, and it didn’t want to continue making commitments over longer horizons,” said Natalie Victal, chief economist at SulAmerica Investimentos.

Still, recent data indicates growth is holding up in the face of tight monetary policy. Analysts have already raised 2024 economic growth forecasts closer to 2%, and both retail sales and formal job creation soared in January, adding urgency to policymaker debate over whether higher wages can revive inflation.

“The monetary policy committee will turn off the autopilot,” said Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc. “Aside from signaling another half-point cut in May, it prepared markets for a more open and data-dependent calibration in the next monetary policy moves.”

--With assistance from Giovanna Serafim, Veronica Vilarinho and Josue Leonel.

(Updates with market reaction in paragraph six)

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