MercoPress. South Atlantic News Agency

Brazil keeps interest rate at record low, despite a spike in food and fuel inflation

Economists expected a more hawkish statement, especially because of longer-term inflation expectations and or willingness to get the public finances back on track.

Brazil’s central bank kept its key interest rate at a record-low 2.00% on Wednesday, maintaining its “forward guidance” pledge to keep rates lower for longer and even the possibility of further easing, despite the recent rise in inflation and fiscal risks.

In a statement accompanying the unanimous decision, the bank’s rate-setting committee known as ‘Copom’ said inflation expectations and forecasts remained “significantly” below target, and left the door open for further “small” cut or cuts.

Copom said the recent spike in inflation due to food and oil prices and a persistently weak exchange rate is “temporary,” but will “closely monitor its evolution.”

Many economists had expected a more hawkish statement, especially on the threat to longer-term inflation expectations from growing uncertainty surrounding the government’s ability – or willingness – to get the public finances back on track.

“It was more dovish than expected. The central bank tried to downplay the inflation shock, there was less emphasis on fiscal risks (than expected), and it left the door open to another rate cut,” said Solange Srour, chief economist at Credit Suisse in Brazil.

“This possibility does not exist, the market does not see this probability,” she said of another rate cut, noting that the rates curve is likely to steepen following Copom’s statement.

Brazil’s economy is undergoing an “uneven” recovery and uncertainty about growth remains high, Copom said, especially when emergency transfer programs are scheduled to expire at the end of the year.

Copom said conditions for its forward guidance remained in place. “The current fiscal regime has not been changed, and long-term inflation expectations remain well anchored”.

Using market-based forecasts for interest rates, and an FX rate of 5.60 reais per dollar evolving according to purchasing power parity, Copom sees inflation around 3.1% this year and next, and 3.3% in 2022.

Using a constant interest rate of 2.00% and the same FX outlook, Copom sees inflation reaching 3.1% this year, 3.2% next year and 3.8% in 2022, the final year of its policy horizon.

Overall, these are slightly higher than the inflation forecasts in Copom’s last policy statement in September. The central bank’s inflation targets for this year, 2021 and 2022 are 4.0%, 2.75% and 3.50%, respectively.