Brazil Says Reforms Needed to Push Rate Cuts Into Overdrive

  • Policy makers cut Selic by 75 basis points for second time
  • Decision expected by 51 of 52 analysts surveyed by Bloomberg

Brazil’s central bank kept its swift pace of interest rate cuts and signaled that any acceleration would require further progress in efforts to control government spending.

The central bank board, led by President Ilan Goldfajn, on Wednesday lowered the benchmark Selic by 75 basis points for the second straight meeting to 12.25 percent, as inflation continues to fall sharply and the economy shows few signs of recovery.

Disinflation has become more widespread and lower food price increases constitute a "favorable supply shock," the bank said in the statement accompanying the decision.

Still, further structural reforms, primarily those containing government spending, are necessary to ensure the sustainability of disinflation and the reduction of the structural interest rate, the monetary authority said. The structural or neutral rate is widely seen as the rate that allows economic growth with stable inflation.

"You would have to have advances that indicate the neutral rate is falling, such as progress in fiscal reforms," Thais Zara, chief economist at Rosenberg Consultores Associados, said by phone in reference to possibly larger rate reductions. "They leave the door open for a more aggressive cut at the next meeting."

Elusive Recovery

President Michel Temer is working to secure legislative support for a proposal that would boost the government’s fiscal accounts by slashing pension expenditures. Last year, Brazil passed a law that caps increases in public spending.

The unanimous key rate decision came hours after a mid-month figure showed annual inflation slowing to 5.02 percent for the first time since mid-2012. Both private sector economists and the central bank now expect inflation at or below the target of 4.5 percent this year and next as the country slowly recovers from its worst recession in over a century.

Brazil’s economic recovery has remained elusive, leaving instead record unemployment and weak demand. Analysts expect gross domestic product growth of 0.7 percent in 2017 after a contraction of at least 7 percent in the previous two years.

Swap rates fell on Thursday as traders increased bets that the central bank may cut the Selic by a full percentage point at its next monetary policy meeting, in April. By the end of the year, policy makers could shave 325 basis points off the benchmark rate, according to estimates from Bank of America Merrill Lynch. After last night’s decision, David Beker, that bank’s chief economist for Brazil, changed his forecast to two 100-basis point cuts in the next two meetings from a previous estimate of two 75-basis point reductions.

The central bank cautioned, however, that inflation risks including a "highly uncertain" global environment remain, and that "the extension of the monetary easing cycle will depend on estimates of the structural interest rate of the Brazilian economy."

Policy makers indicated they will not accelerate the pace of easing "unless the Copom sees improvements in the balance of risks for inflation and/or a decline of the neutral/structural rate for the economy," Alberto Ramos, chief Latin America economist at Goldman Sachs, said in an e-mailed note.

For a version in English of the Brazil central bank statement, click here.

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