MercoPress. South Atlantic News Agency

Brazil softens Selic rate but concerns grow about fiscal stimulus on election year and impact of El Niño

Inflation expectations have risen steadily as President Lula da Silva rolls out measures boosting household spending as he bids for re-election in October

Brazil’s central bank interest rate-setting committee, Copom, ‌unanimously voted on Wednesday to lower its benchmark Selic rate by 25 basis points to 14.25%, a level last seen in May 2025, ‌but acknowledging a tougher inflation outlook given the risks from election-year fiscal stimulus and the impact of a likely El Nino weather pattern shock.

Copom said in its policy statement…”it reaffirms that the total magnitude of the calibration cycle will be established in light of new information“. The decision comes as economists scale back expectations for easing this year amid an oil price shock linked to the U.S.-Israeli war with Iran.

Inflation expectations have risen steadily as President Lula da Silva rolls out measures boosting household spending as he bids for re-election in October.

Policymakers introduced economic stimulus as an upside risk for inflation in their statement, noting concerns of it ”weakening some of ‌the usual transmission channels of monetary policy.”

In effect the central bank raised on Wednesday its annual inflation forecast for the policy horizon, the fourth quarter of 2027, to 3.7% from 3.5% previously, which is above the official 3% target. It also raised this year's projection to 5.2% ⁠from 4.6%.

Liam Peach, senior emerging markets economist at Capital Economics, said policymakers seemed to be justifying the latest rate cut and keeping the door open to more easing despite worsening projections and rising inflation risks.

“The easing cycle is likely to become stop-start from here on, and the extent of further rate cuts will be data dependent as inflation continues to rise this year,” he said. He now forecasts a total of 50 basis points of cuts in the next four meetings, bringing the Selic to 13.75% by the end of the year.

Policymakers ‌began cutting rates in March, arguing that their earlier aggressive tightening had produced visible effects on economic activity and lending, opening room for “calibration” of the benchmark rate while keeping it in restrictive territory.

Although oil prices have eased on signs of progress toward a U.S.-Iran deal to end their conflict, challenges for Brazil's central bank have ‌mounted on other fronts since its last meeting in late April.

Annual inflation accelerated to 4.72% in May, while market expectations have risen not only for this year and next but also for 2028, signaling doubts about the bank's ability to anchor prices on a longer horizon, independent of current shocks.

Central bank president Gabriel Galipolo added worries on the likely impact of El Nino weather cycle on ‌supply-side prices.

Economists have also noted that a government-backed bill in Congress to guarantee workers two days off each week could add to price pressures by raising costs in an economy where income growth has outpaced productivity in a tight labor market.