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Brazil Lifts Rates by Half a Point to 13.75%, Flags Another Hike Possible

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(Bloomberg) -- Brazil’s central bank raised its key interest rate by half a percentage point and left the door open for a smaller boost in September as it shifts its focus to the outlook for inflation more than a year ahead.

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The bank lifted the Selic to 13.75% late on Wednesday, prolonging a monetary tightening cycle that’s increased borrowing costs by 11.75 percentage points since March 2021. In a statement, policy makers wrote that they will give more emphasis to price forecasts for early 2024 as recent tax changes leave more near-term estimates in flux.

“The Committee will evaluate the need for a residual adjustment, of lower magnitude, in its next meeting,” they wrote. “The Copom emphasizes that it will remain vigilant and that future policy steps could be adjusted to ensure the convergence of inflation towards its targets.”

Board members led by Roberto Campos Neto are battling the impacts of fuel and food shocks that have kept consumer prices rising above 10% a year even as growth remains subdued. Recently, tax cuts provided short-term relief to transportation costs, and inflation has eased. On the other hand, congress passed a $7.6 billion social aid package that’s expected to support demand while the labor market firms.

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“The plan for September is either to keep rates steady or to raise them by 25 basis points,” said Fabio Kanczuk, a former central bank director who’s now head of macroeconomics at Asa Investments. “The outlook will continue to be difficult,” he said, adding that he expects the Selic to peak at 14.25%.

Swap rates on the contract maturing in January 2023, which signal expectations for the key rate at year-end, slipped four basis points to 13.75% in morning trading on Thursday, while the contract due in January 2025 dropped 25 basis points. The real gained 0.3% to 5.2668 per dollar.

Inflation Projections

Brazil’s jobless rate has fallen to the lowest since December 2015 in a labor market recovery described by the central bank as “stronger than expected.” Furthermore, President Jair Bolsonaro and his main rival, Luiz Inacio Lula da Silva, have both pledged to boost social aid if victorious in October’s election.

In their statement, policy makers wrote that inflation is high when considering both volatile items and also core readings that strip out food and energy costs. An even more restrictive tightening cycle is appropriate given the risk that inflation projections become unhinged, they wrote.

“The Committee assesses that the possibility that fiscal policies that support aggregate demand become permanent heightens the upside risks of the inflationary scenario,” board members wrote.

What Bloomberg Economics Says

“Brazil’s central bank delivered the hike markets expected and signaled another small move is possible in September. There was one key innovation -- the BCB said its decision was guided by first-quarter 2024 inflation forecasts rather than year-end projections for 2023 and 2024. Policy makers’ arguments suggest they are keen on ending the cycle, regardless of unanchored expectations.

--Adriana Dupita, Brazil economist

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Consumer prices will rise 4.6% next year and 3.5% in the first quarter of 2024 on an annual basis, according to central bank estimates. Policy makers target inflation at 3.25% and 3% in 2023 and 2024, respectively.

Downward Revisions

At the same time, the tightening cycle is at an advanced stage, and its full impact on the economy is yet to be seen, board members wrote in the statement. In the bank’s view, the international environment is “adverse and volatile, with marked downward revisions on prospective global growth.”

Policy makers also reiterated the need for additional caution in their actions, as well as the heightened uncertainty in both local and international markets.

“The central bank set a high bar for a rate hike of 25 basis points in the event that the outlook worsens,” said Gustavo Pessoa, a partner at Legacy Capital. “They are heading toward the end of the tightening cycle.”

Despite headwinds to activity, economists surveyed by the central bank have raised their 2023 inflation estimates for 17 consecutive weeks, to 5.33%. They are also forecasting that borrowing costs will remain high for longer.

Annual inflation stood at 11.39% in mid-July, the most recent reading. For many investors, there’s still work to be done on rates.

“Our updated forecast will be 14% for the end of this year,” said Brendan McKenna, a currency strategist at Wells Fargo Securities LLC. “The committee’s fiscal outlook will be the driver of one more 25 basis-point hike.”

(Updates with market moves in 6th paragraph)

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