Brazil’s rate cuts may pause after cautious Central Bank signal

Amid an oil supply shock caused by the war in the Middle East, COPOM reinforced the increase in uncertainty and the deterioration of the inflation outlook. The committee’s projection for the relevant monetary-policy horizon was revised significantly, from 3.3% in the third quarter of 2027 to 3.5% in the fourth quarter of next year.

“At this moment, inflation projections have moved further away from the target in the relevant horizon for monetary policy. At the same time, uncertainty surrounding these projections has risen considerably because of the lack of clarity over the duration of the conflicts and their effects on the assumptions used in the projection models analyzed,” COPOM said in the statement released on Wednesday.

Cloudy outlook

For Helena Veronese, chief economist at B.Side Investimentos, the statement was tough and made clear that the Selic-cutting cycle depends on developments in the war in the Middle East.

“The text was tougher, in the sense that the authority did not want to commit to anything, neither the length of the cutting cycle nor its pace,” she said. “The truth is that with each passing day it becomes harder for the Central Bank to continue cutting the Selic because the outcome of the war is highly uncertain.”

In the economist’s view, by not ending the cycle now, the monetary authority is signaling that it will continue lowering the base rate at upcoming meetings, but cautiously. “For now, we will not change our forecast [for the Selic at 12.5% by the end of the year]. But that will depend much more on the course of the war than on the Central Bank’s communication,” she said. “We are in a very bad week, with no signs that there is any kind of negotiation between the United States and Iran. If that changes, the prospect of cuts remains.”

For Rafael Cardoso, chief economist at Banco Daycoval, the statement was tough enough to suggest the possibility of a pause in the Selic-cutting cycle. He highlighted the significant increase in the Central Bank’s inflation forecast, which surprised him, since he had expected the projection to remain at 3.3%.

Despite the worsening inflation outlook caused by the war in the Middle East, factors such as the real’s appreciation since the previous COPOM meeting, the shift in the relevant horizon from the third to the fourth quarter of next year, and expectations of a higher Selic in the Central Bank’s Focus survey could have offset the outlook for a higher IPCA consumer price index in the short term.

For Felipe Rodrigo Oliveira, chief economist at MAG Investimentos, the change in the inflation forecast from 3.3% to 3.5% is a signal from COPOM to the market. He had also expected the projection to remain at 3.3%, with a possible increase to 3.4%, and said he was therefore surprised.

Given COPOM’s more conservative signals in Wednesday’s statement, the possibility of accelerating the pace of cuts to 50 bp is not plausible for now, Oliveira said.

“The 50-bp cut in June, which still had some chance of happening, is essentially off the table. In June, COPOM will likely be between another 25-bp cut and holding [the Selic] steady,” Oliveira said. Although he has not yet changed his forecast that the Selic will end the year at 13%, Oliveira said there is indeed a bias toward higher interest rates.

Cardoso, of Daycoval, takes a similar view and said his expectation of sequential 25-bp cuts through the end of the year, taking the Selic to 13.25%, is under threat given the signal that the cycle could be interrupted.

In addition to the higher inflation forecast for the relevant horizon, he highlighted COPOM’s inclusion of a reference to potential secondary effects from the oil shock in its balance of risks. In this sense, the committee emphasized its concern over the possibility that longer-term inflation expectations could become unanchored, Cardoso said.

Pessimistic view

With a more pessimistic view than most of the market, Adam Capital chief economist, Juliano Cecílio, said the decision to cut the Selic shows the Central Bank is not giving weight to the factors currently fueling inflation.

“Inflation is not the object of the Central Bank’s reaction function at this moment. That becomes clear when you see that it raised its inflation forecast for the relevant horizon, recognizes a rebound in activity at the start of this year, and sees a worsening in current inflation and underlying measures,” Cecílio said.

“The Central Bank is working with a ‘hope’ that the supply shock will improve quickly, but it is important to remember that there is also a demand shock. The truth is that even before the war it was not prudent to begin cutting rates. Just look at labor-market numbers and activity indicators. The economy is overheated.”