Brazil central bank hikes rates 50 bps to 11.25%, seeks ‘credible’ fiscal policy

SAO PAULO (ICIS)–Brazil’s central bank monetary policy committee (Copom) voted unanimously late on Wednesday to hike the main interest rate benchmark, the Selic, by 50 basis points to 11.25%, to fend off rising inflation and a depreciating Brazilian real.

• Central bank urges government to put fiscal house in order
• H1 October inflation data reveals that upward trend continues
• Despite high borrowing costs, car sales at decade-high in October

The 50 basis point increase is a double-down on the first 25 basis point increase in September which put an end to the monetary policy easing which started in August 2023 after a post-inflation crisis.

Copom did not mention the market fallout which followed US Republican candidate Donald Trump’s victory in the presidential election, as global investors are wary about radical changes in US trade policy via higher import tariffs, among others.

Instead, Copom focused on the healthy domestic economy and strong labor market which has put upward pressure on prices.

After a small fall in August, the annual rate of inflation ticked higher in September – an upward trend that started May – to stand at 4.4%. Indicators for H1 October showed inflation ticking up further to 4.5%.

The Banco Central do Brasil’s (BCB) own inflation expectations reflect this trend, with inflation expected to end this year at 4.6% before falling to 4.0% in 2025. The BCB’s mandate is to keep inflation at around 3%.

“The scenario remains marked by resilient economic activity, labor market pressures, positive output gap, an increase in the inflation projections, and deanchored expectations, which requires a more contractionary monetary policy,” said Copom.

“[Copom] judges that this decision [increase in the Selic] is consistent with the strategy for inflation convergence to a level around its target throughout the relevant horizon for monetary policy. Without compromising its fundamental objective of ensuring price stability, this decision also implies smoothing economic fluctuations and fostering full employment.”

Petrochemical-intensive industrial companies have repeatedly said high interest rates have harmed sales as consumers think twice before purchasing durable goods on credit due to high borrowing costs.

One vocal opponent to high rates is automotive trade group Anfavea, although its own figures this week showed sales riding at a high not seen since 2014, regardless of high borrowing costs.

The automotive industry is a major global consumer of petrochemicals, which make up more than one-third of the raw material costs of an average vehicle, driving demand for chemicals such polypropylene (PP), nylon, polystyrene (PS), styrene butadiene rubber (SBR), polyurethane (PU), methyl methacrylate (MMA) and polymethyl methacrylate (PMMA), among others.

Meanwhile, Brazilian president Lula’s cabinet is looking to strengthen the country’s industrial sectors to fulfil his Workers Party (PT) electoral promise to create more and better paid industrial jobs. As a result, Lula and several of his  officials have repeatedly and publicly criticized the BCB for its interest rates policy.

Meanwhile, central bank governor Roberto Campos Neto, appointed by the previous center-right Jair Bolsonaro administration, will end his term in December, when Lula appointed Gabriel Galipolo will succeed him. It is a move that has put some investors on alert due to his closeness to Lula, as he may prioritize the cabinet’s demands instead of the bank’s inflation target, its main mandate.

But as global markets increasingly look at Brazil, Galipolo has fallen in line and also voted to increase rates in the last two Copom meetings.

CABINET URGED TO END DEFICIT
The Brazilian cabinet, presided over by Luiz Inacio Lula da Silva, was expected to run a fiscal deficit this year in an attempt to expand public services without increasing taxes.

Investors and analysts have been piling pressure on the government by punishing the Brazilian real (R), which has depreciated sharply in the past few months against the US dollar, making dollar-denominated imports into Brazil more expensive and ultimately filtering down in the form of higher inflation.

At the start of 2024, the real was trading at $1:4.85. But the exchange rate stood at $1:5.69 on Wednesday, a depreciation of nearly 15%.

On Wednesday, Copom joined the chorus of voices asking for stricter fiscal policy, arguing that to stop the real losing ground it is necessary a “credible fiscal policy committed to debt sustainability, with the presentation and execution of structural measures” in the public accounts.

The Brazilian cabinet is reportedly working against the clock this week on those measures, and Finance Minister Fernando Haddad even cancelled an official trip to Europe this week to focus on this.

“The perception of agents [in the market] about the fiscal scenario has significantly impacted asset prices and expectations, especially the risk premium and the exchange rate. [A credible fiscal policy] will contribute to the anchoring of inflation expectations and to the reduction in the risk premia of financial assets, therefore impacting monetary policy.”

Analysts at Capital Economics on Wednesday also highlighted the diplomatic but very clear request from the central bank to the government – without stricter fiscal policies aiming to reduce the deficit, investors will continue making the central bank’s work on inflation harder as they bet against Brazilian assets, including its currency.

“[The hike] has more to do with the domestic macro backdrop and shoring up monetary policy credibility than a response to the market fallout following Trump’s victory … [Copom’s] Concerns will have only been amplified by recent data and developments, with the accompanying statement reiterating that ‘economic activity and labor market continues to exhibit strength’,” the analysts said.

“Alongside all of this, Copom members are probably also feeling compelled to tighten policy in order to shore up their credibility amid investor concerns about politicization of monetary policy. This strikes at an important point – the central bank is responding to Brazil-specific factors rather than the financial market fallout from Trump’s victory, especially given that the real is up by around 1% against the dollar today [6 November].”

Capital Economics said Copom’s intention to raise rates further if necessary is likely to become a reality in coming months, expecting the Selic to rise further by 75bps more to reach 12% in early 2025.

“That said, the risks are skewed to the upside, particularly if the government fails to soothe investors’ concerns about the fiscal position.” they concluded.

Focus article by Jonathan Lopez