Brazil kicks off interest rate hikes more aggressively than expected

[BRASILIA] Brazil's central bank delivered its first interest rate hike in nearly six years on Wednesday, a larger-than-expected 75 basis point increase to 2.75 per cent, and flagged a similar move in May to fight inflation despite rising economic uncertainty.

The decision to raise borrowing costs comes at a fragile moment, as a raging second wave of the Covid-19 pandemic is sweeping Latin America's largest economy. Brazil's death toll and case count trails only the United States, and its economy is on course to contract in the first quarter.

Still, the bank's rate-setting committee, known as Copom, said its decision to raise the benchmark rate from a record-low 2 per cent was unanimous, and signalled a hike of the same size at its next meeting unless the outlook changes significantly.

All but one of 30 economists polled by Reuters had expected a smaller increase to 2.5 per cent.

Economists said the decision showed that policymakers are concerned more with upside risks to inflation than downside risks to growth. Weaning financial markets off extraordinarily low rates with a bold move should help anchor the inflation outlook and support Brazil's currency.

"Frontloading the policy normalisation process is a stronger and quicker way of stabilising financial markets, supporting the real and minimising the risk of inflation ending the year above target," said Luciano Rostagno, chief strategist at Mizuho Bank in Sao Paulo.

The last time Brazil raised interest rates was July 2015, when the benchmark Selic rate rose 50 basis points to 14.25 per cent, and it last lifted rates by 75 basis points in June 2010.

With 12-month inflation running at 5.2 per cent, well above the central bank's year-end target of 3.75 per cent, Copom said in its accompanying statement that this increase marks the start of a "partial normalisation" process for monetary policy.

Using market-based interest and exchange rate forecasts, Copom said inflation is on course to end this year at 5 per cent, uncomfortably close to the upper 5.25 per cent limit of its target band.

"For the next meeting, unless there is a significant change in inflation projections or in the balance of risks, the Committee foresees the continuation of the partial normalisation process with another adjustment, of the same magnitude, in the degree of monetary stimulus," they said.

Copom highlighted that its relevant policy horizon is "mainly" 2022, when inflation should ease back to the official year-end goal of 3.5 per cent.

Alberto Ramos, head of Latin American research at Goldman Sachs, said the central bank is "frontloading the partial normalisation of monetary policy but is not at this juncture aiming for a fast climb towards a neutral monetary stance".

A central bank survey of economists this week forecast the Selic ending this year at 4.5 per cent and next year at 5.5 per cent. Most economists reckon the "neutral" rate, when the economy runs at full employment and potential growth while keeping inflation constant, is around 6-6.5 per cent.

The sharp rate hike may help to put a floor under the real, which had followed last year's 30 per cent slump against the US dollar with a further 8 per cent decline so far this year. That has added to inflationary pressures and prompted the central bank to step up currency market interventions in recent weeks.

REUTERS