Brazil’s End of Rate Hikes Up in the Air as Prices Surge

(Bloomberg) -- Brazil's central bank raised its benchmark interest rate by a full percentage point and opened the door to a longer monetary tightening campaign, with another likely increase of smaller size in June to battle rampant inflation.

Policy makers lifted the Selic to 12.75% late on Wednesday, extending total hikes to borrowing costs since last year to a total of 10.75 percentage points. In an accompanying statement, they wrote that future monetary policy steps could be adjusted to ensure inflation eases to target.

“For its next meeting, the Committee foresees as likely an extension of the cycle, with an adjustment of lower magnitude,” they wrote. “The Committee emphasizes that it will persist in its strategy until the disinflation process consolidates and anchors expectations around its targets.”

The Brazilian real weakened on Thursday, following losses in most emerging-market currencies, as the dollar strengthened worldwide. Swap rates rose.

Policy makers led by Roberto Campos Neto are grappling with persistent shocks that sent consumer prices rising more than 12% in early April. Fuel became more expensive in the wake of Russia's invasion of Ukraine and now public servants are demanding higher wages. Economists, anticipating that Brazil will require even more aggressive tightening, have lifted their inflation forecasts further above target.

“At no point in the statement does the central bank say it's going to stop” raising rates, said Caio Megale, chief economist at XP Inc. “It's a tougher statement than what the market was expecting. It leaves the door open for perhaps a longer and more intense adjustment.”

The guidance marks an important shift from the central bank's previous communication signaling intentions to wrap up the tightening cycle this week.

Brazil's decision came hours after the U.S. Federal Reserve increased rates by a half percentage point, its biggest hike since 2000. In Latin America, Chile is expected to raise borrowing costs on Thursday as annual inflation approaches double digits, while Colombia lifted rates to a five-year high last week.

What Bloomberg Economics Says
Brazil's central bank delivered on just half of its pledge from March -- it raised the policy rate by 100 basis points at the May meeting, but switched gears by signaling another, smaller increase next month. The reason -- de-anchored inflation expectations, which are posing as much a problem as double-digit current inflation. There's a risk neither declines fast enough -- or at all -- to allow policy makers to end the tightening cycle by June.
-- Adriana Dupita, Latin America economist
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In its statement, the bank board said that the global economic environment has worsened. “Inflationary pressures arising from the pandemic period have intensified due to supply problems related to the new wave of Covid-19 in China and the war in Ukraine,” they wrote.

‘High Bar'

Locally, there are mounting signs that aggressive borrowing cost hikes are weighing on consumption. Economic growth will not surpass 1% this year or next, according to a central bank survey of analysts published on Monday.

A bigger-than-expected slowdown in economic activity represents a top downside risk to inflation, according to the central bank statement. Additionally, Brazil will be gearing up for presidential elections in October, with politics making it more difficult to continue hiking, according to Gustavo Pessoa, a partner at Legacy Capital.

“The bar is very high to raise rates in August, in the middle of the election campaign,” he said. “Whether or not the bank will hike at the next meeting should depend a lot on data and on the exchange rate.”

Policy makers also wrote that uncertainty in its assumptions and projections is higher than usual, and that assessing the outlook requires additional caution.

‘No Guarantee'

Still, there's no denying Brazil's inflation problem. Consumer prices have continued to rise more than expected, and various measures of inflation are above target, policy makers said.

“The Committee considers that, given its inflation projections and the risk of a de-anchoring of long-term expectations, it is appropriate to continue advancing in the process of monetary tightening significantly into even more restrictive territory,” they wrote in the statement.

Brazil's consumer prices will rise 7.89% this year and 4.1% next, according to the central bank's latest survey of economists. Policy makers target inflation at 3.5% and 3.25% in 2022 and 2023, respectively.

“The central bank didn't mention that we're close to the end of the cycle,” said Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc. “There's no guarantee that the cycle ends in June.”