MercoPress. South Atlantic News Agency

Brazil keeps key interest rate at record low 2%; anticipates “forward guidance” instead of further cuts

In a statement accompanying the unanimous decision, “Copom” said inflation in the short term may be higher than previously thought

Brazil’s central bank kept its key interest rate at a record-low 2.00% on Wednesday, pledging to stimulate the coronavirus-hit economy with “forward guidance” rather than more rate cuts because of the risk to financial market stability that they could pose.

In a statement accompanying the unanimous decision, the bank’s rate-setting committee known as “Copom” said inflation in the short term may be higher than previously thought, but a bit lower over the next two years than previously forecast.

The decision to hold the Selic rate at 2.00% broke a run of nine consecutive cuts, with policymakers repeating their recent warnings that any further easing could threaten financial market stability.

But Copom did not signal the end of the easing cycle, noting that uncertainty surrounding the economic recovery is unusually high due to the COVID-19 pandemic, fiscal stimulus is likely to expire at the end of the year, and the dominant services sector remains weak.

“The statement was dovish, relative to expectations, and indicated more of a pause rather than the end of the cycle,” said Tatiana Pinheiro, chief economist at BNP Asset Management in Sao Paulo.

“At the end of the day, if the fiscal situation improves and inflation is still below target, Copom still has room to cut (rates). The door is still open,” she said.

Copom said its forward guidance means the Selic is unlikely to be raised over the next year or possibly into 2022 unless inflation gets back up towards the central bank’s targets.

“To provide the monetary stimulus deemed adequate to meet the inflation target, but maintaining the necessary caution for prudential reasons, the Copom considered adequate to use forward guidance as an additional monetary policy tool,” Copom said.

Any remaining space for monetary policy stimulus, if it exists, should be “small”, Copom said, and dependent on the fiscal trajectory and inflation outlook.

In its statement, Copom said its “hybrid” forecasting model, using market-based interest rate forecasts and a constant exchange rate of 5.30 reais per dollar projected inflation around 2.1% this year, 2.9% next year and 3.3% in 2022.

Last month, using a market-based rate outlook and an exchange rate of 5.20 reais per dollar, Copom projected inflation of around 1.9% this year, 3.0% next and 3.4% in 2022.

The central bank’s official 2020, 2021 and 2022 inflation goals are 4.00%, 3.75% and 3.50, respectively. Copom expects inflation to get closer to target in 2022.

Copom again warned that risks to the government’s fiscal path and reforms agenda could put upward pressure on market-based rates and risk premiums.