Brazil’s central bank makes first interest rate hike in six years

Brazil’s central bank (CB) delivered its first interest rate hike in nearly six years on Wednesday, a larger-than-expected 75 basis point increase to 2.75%, 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 2.00% was unanimous, and signaled 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 2.50%.

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 normalization process is a stronger and quicker way of stabilizing 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%, and it last lifted rates by 75 basis points in June 2010.

With 12-month inflation running at 5.2%, well above the central bank’s year-end target of 3.75%, Copom said in its accompanying statement that this increase marks the start of a “partial normalization” process for monetary policy.

Using market-based interest and exchange rate forecasts, Copom said inflation is on course to end this year at 5.0%, uncomfortably close to the upper 5.25% 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 normalization 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 3.50%.

Alberto Ramos, head of Latin American research at Goldman Sachs, said the central bank is “frontloading the partial normalization 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 4.50% and next year at 5.50%. Most economists reckon the “neutral” rate, when the economy runs at full employment and potential growth while keeping inflation constant, is around 6.0%-6.5%.

The sharp rate hike may help to put a floor under the real, which had followed last year’s 30% slump against the dollar with a further 8% 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.

Brazil is lowering import tariffs on almost 1,500 capital goods and white goods by 10%, the economy ministry said on Wednesday, a measure aimed at reducing import costs and consumer prices and which will take effect later this month.

The reduction will “lower machinery and equipment costs, increasing the competitiveness of industry, services and agribusiness, resulting in lower prices for the Brazilian consumer,” the ministry said in a statement.

Import tariffs on these goods currently vary between zero and 16%, the ministry said.

“All 2% rates will be reduced to zero, reducing bureaucracy and making life easier for importers and consumers,” the ministry added.

Annual inflation in Brazil is running at its highest in four years, at 5.20%, and is widely expected to rise in the coming months to over 6%.

Meanwhile, Brazil’s lower house approved a new regulatory framework for the natural gas sector in the early hours of Wednesday, a move the government hopes will increase competition in the industry.

The bill, which garnered support from industrial consumers, will now be signed into law by President Jair Bolsonaro.

“In this difficult moment, this approval bodes well for the economy,” said Paulo Pedrosa, president of Abrace, an industry group of large energy users.

He said the new law would help attract new investments to the sector and increase predictability.

Under the bill, companies interested in building gas pipelines will need a simple authorization rather than a more complex concession contract. Energy regulator ANP will have more power to foster competition and reduce market concentration.