MercoPress. South Atlantic News Agency

Brazil central bank keeps interest rate at record low 2%, but admits scenario of inflation expectations

In a statement accompanying the unanimous decision, Copom said conditions for forward guidance still hold, and that the economy still requires a large amount of monetary stimulus.

Brazil’s central bank kept its key interest rate at a record low 2.00% on Wednesday, as expected, but gave the first sign it could soon drop its pledge to keep rates lower for longer as inflation expectations converge toward target.

In a statement accompanying the unanimous decision, the bank’s rate-setting committee Copom said conditions for forward guidance still hold, and that the economy still requires a large amount of monetary stimulus.

But for the first time, policymakers outlined a scenario where that guidance could be withdrawn. “A scenario of inflation expectations converging to target suggests that the conditions for maintaining the forward guidance may soon no longer apply,” Copom said.

This would not “mechanically” imply that interest rates will rise, and in the event, policy would still be guided by the bank’s inflation-targeting framework.

Drausio Giacomelli, head of emerging market strategy at Deutsche Bank in New York, noted an accumulation of inflationary pressures including rising commodity prices and a 30% domestic currency depreciation this year.

“Taking all that into account, you have to start to signal the expiration date for forward guidance, although removing it doesn’t mean they have to hike rates. It is not done overnight,” he said.

“People should not be concerned. There is a lot of liquidity in the system that has to be tapered before Copom hikes rates. Their exit strategy will be discussed in the coming months before they actually remove forward guidance,” he said.

Copom said the recent spike in inflation was temporary, and that it will continue to monitor developments closely, “in particular the core inflation readings.”

Figures this week showed annual consumer inflation in November topping 4% for the first time since February. That is the mid-point of the central bank’s target range for the year, and more than double the rate it was only six months earlier.

Using market-based forecasts for interest rates, and an exchange rate of 5.25 reais per dollar, Copom sees inflation around 4.3% this year and 3.4% next year, and 3.4% in 2022.

Using a constant interest rate of 2.00% and the same FX outlook, Copom sees inflation reaching 4.3% this year, 3.5% next year and 4.0% in 2022, the final year of its policy horizon.

The central bank’s inflation targets for this year, 2021 and 2022 are 4.0%, 3.75% and 3.50%, respectively. It was the third consecutive policy meeting in which Copom has left the Selic rate at 2.00%, after cutting it to the all-time low in August.