(Bloomberg) -- Brazil’s central bank lifted its key interest rate by one percentage point and surprised investors by promising two more hikes of the same size, its strongest move yet to recover investor confidence and tame inflation expectations that have been propelled by public spending and a hot economy.
Board members boosted the Selic to 12.25% late on Wednesday as expected by 14 of 35 economists in a Bloomberg survey, with all others expecting a smaller rise. In an accompanying statement, they wrote that the outlook has been marked by a further de-anchoring of inflation expectations and stronger-than-expected activity, which together require even more restrictive monetary policy.
“In light of a more adverse scenario for inflation convergence, the Committee anticipates further adjustments of the same magnitude in the next two meetings, if the scenario evolves as expected,” board members wrote.
The central bank also announced that it would hold a credit line auction of up to $4 billion on Dec. 12. Through currency credit-line auctions, the central bank sells the so-called dollar spot and pledges to buy it back in the near future in exchange for a certain interest rate. Those moves try to supply liquidity to the spot market.
Policymakers led by Roberto Campos Neto are facing intense pressure to tame inflation forecasts that are well above the 3% target. Household spending is running hot due to record low unemployment and expanded welfare benefits. Investors are also growing increasingly skeptical of the government’s pledges to shore up public accounts, after an austerity plan was announced together with tax breaks for low-income families.
“Given the sharp deterioration in the inflation outlook, a decisive monetary policy decision was necessary, and the central bank delivered,” said Alberto Ramos, chief Latin America economist at Goldman Sachs & Co. LLC. “With a hike of one percentage point and forward guidance for two identical increases in the next two meetings, the central bank moves ahead of the curve.”
Central bankers have now lifted borrowing costs by 1.75 percentage points since September, and analysts see the tightening cycle extending through early 2025. Two additional hikes of 100 basis points would lift the Selic to 14.25% — above the level seen in the bank’s post-pandemic rate-hike campaign.
Brazil’s real jumped 1.3% in early morning trading on Thursday following the rate hike and the central bank’s forward guidance. Short and medium-term interest rate swaps rose.
Fiscal Discipline
In the statement, board members wrote that they have been closely monitoring the recent public spending developments and the impact on monetary policy.
What Bloomberg Economics Says
“Reintroducing forward guidance is likely an attempt to anchor rate expectations. We think the more hawkish move will help restore some of the BCB’s credibility, but unless there’s firmer signs of fiscal discipline, it may not be enough to erase recent market losses or the sharp rise in inflation expectations.”
— Adriana Dupita, Brazil and Argentina economist
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Without naming the government’s new spending cut plan that dismayed markets, policymakers wrote, “the perception of agents about the recent fiscal announcement has significantly impacted asset prices and expectations, especially the risk premium, inflation expectations and the exchange rate.”
“The Committee judges that these impacts contribute to a more adverse inflation dynamic,” they wrote.
The plan announced last month calls for cutting some 70 billion reais ($11.7 billion) through 2026. While investors were holding out for a strong austerity push, the government also said it would exempt workers with monthly salaries of up to 5,000 reais from paying income taxes, a move that fuels demand.
Annual inflation accelerated to 4.87% in November, above the 4.5% tolerance range ceiling. Consumer prices have been pressured by a weaker real, which has tumbled over 17% this year, the biggest drop among major currencies.
The central bank’s inflation projections for the second quarter of 2026, which is the current relevant horizon for monetary policy, rose to 4%, according to the statement.
“It’s worthwhile noting that the total size of the tightening cycle remains open,” said Sergio Goldenstein, chief strategist at Renascenca Dtvm Ltda. “If there’s no substantial improvement in the balance of risks, then the bank is signaling that 14.25% will be the floor for the end-of-cycle rate.”
Market Reaction
At the same time, Brazil’s economy has remained resilient. Retail sales rose by 0.4% on the month in October, surprising analysts who were expecting a decline of 0.2% during the period, the national statistics agency reported early Thursday.
Gross domestic product expanded more than forecast in the third quarter, supported by key sectors from industry to family consumption, and it is on track to increase over 3% in 2024.
In their statement, central bankers said both overall economic activity and the labor market continue to show strength.
This was Campos Neto’s last rate decision, as his term ends this month. Gabriel Galipolo, a bank board member and an ally of President Luiz Inacio Lula da Silva, will assume the post as governor beginning in January.
Earlier this week the Senate approved three new bank directors, including Nilton David as monetary policy director. Lula has now named the majority of the institution’s board members.
Financial markets will respond well to the central bank’s decision, according to Mirella Hirakawa, research coordinator at Buysidebrazil.
“The decision showed the central bank to be tougher than expected, mainly through anticipating the next two rate hikes,” she said. “This is a shock of high rates. It shows proactive monetary policy.”
--With assistance from Giovanna Serafim, Josue Leonel and Felipe Saturnino.
(Updates with currency move in 8th paragraph and retail sales in 17th paragraph)
