Brazil Pledges to End Monetary Stimulus With Steeper Rate Hikes

(Bloomberg) -- Brazil’s central bank delivered its most aggressive interest rate increase in nearly two decades and promised to quickly reintroduce a restrictive monetary policy to tame above-target inflation.

The bank on Wednesday lifted the benchmark Selic by a full percentage point to 5.25%, as forecast by the vast majority of analysts surveyed by Bloomberg. Policy makers said they foresee another hike of the same magnitude next month, with the key rate eventually surpassing a neutral level that economists estimate at 6% to 7%.

“The recent deterioration of inertial components of inflation, in a moment of reopening of the service sector, could result in an additional deterioration of inflation expectations,” they wrote in a statement accompanying their decision. “A quicker monetary adjustment is the most appropriate to guarantee the anchoring of inflation expectations.”

Brazil’s central bank, led by its President Roberto Campos Neto, has been among the most aggressive in the world, boosting rates by 325 basis points since March. But price pressures are mounting as local officials roll back the last few virus restrictions in place, forcing policy makers to make an even stronger effort to hit next year’s inflation target.

What Bloomberg Economics Says

“Brazil’s central bank sped up the pace of rate hikes, pledged another full-point increase in September and signaled above-neutral interest rates at the end of the cycle. The hawkish message will likely lead markets to price in an even steeper increase in rates than currently embedded in the yield curve. It adds a significant upside bias to our year-end Selic forecast of 6.5% -- now under revision.”

--Adriana Dupita, Latin America economist

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Annual inflation hit 8.59% in mid-July, compared to goals of 3.75% for this year and 3.5% for next. Analysts surveyed by the bank see prices above target through 2022, even as they expect borrowing costs to rise to 7% by December.

In their statement, policy makers said cost of living increases have been persistent. Costlier services and industrial goods have fueled core inflation, and adverse weather may further pressure food and electricity bills, they wrote.

Read more: Brazil Set for Biggest Rate Hike Since 2003 as Economy Reopens

“The central bank showed it was concerned about services sector inflation,” said Joao Leal, an economist at Rio Bravo Investimentos. “They affirmed that there’s persistent inflation pressure that could worsen 2022 expectations. As a result, they will likely lift the Selic to 7.5% to 8% by year’s end.”

‘Robust’ Recovery

The spread of the delta coronavirus strain has added risk to the global economic recovery, bank board members wrote, adding that the outlook for emerging markets remains benign given monetary and fiscal stimulus.

In particular, Brazil’s recent economic indicators have evolved adequately, they said. As a result, the central bank stands behind growth forecasts which foresee “a robust economic recovery during the second semester.”

While the virus is still killing almost 1,000 people in Brazil a day, that’s down from a peak of more than 4,200. Hospital occupancy rates have plummeted, with intensive-care units across the nation about 60% to 65% full, down from more than 95% earlier this year.

Read more: Brazil Lifts Covid Restrictions as Cases, Deaths Finally Ease

In recent months, policy makers have been criticized for falling behind the curve as inflation surged in Latin America’s largest economy. Wednesday’s decision will help boost their credibility, according to David Beker, head of Brazil for Bank of America Securities Inc.

“Going above neutral will help re-anchor inflation expectations for 2022,” Beker said. “It was a hawkish statement, but an expected one as well. They did what the market expected they would do.”

©2021 Bloomberg L.P.