The Brazilian Central Bank (BCB) this week cut rates by 100 basis points to 9.25% very much in line with both market and consensus expectations. This is the seventh consecutive cut in a cycle that now totals 500 basis points since October 2016, with still a way to go.
The expected and unanimous decision was followed by a communiqué that directly referenced to the continuity of the current pace of cutting in September, leading many market participants to believe that another 100bp should be the base case from here, as opposed to slowing to 75 basis points, which is still a possibility.
“As such, we incorporate this continuity into our view and lower our estimate of the terminal point for the Selic rate to 7.50%, from 8.0%,” Joao Pedro Riberio, Latin America strategist with Nomura Securities wrote in a note to clients on June 26th. “Risks associated with looser monetary policy forecasts remain, particularly related to fiscal and policy-relevant reform initiatives in Congress, but the current low inflation environment and the BCB’s recent reactions currently support these downward revisions, in our view.”
It is important to note that the monetary policy committee noted “uncertainty” around stalled structural reforms might limit the decline of the real neutral rate, and it tied the easing cycle more closely to cyclical factors (sluggish growth and significant disinflation).
The committee also linked the pace of further cuts to the trajectory of its baseline scenario, “which implies it is putting more emphasis on near-term inflation and 12-month forecasts, which remain near or below target than Brazil’s parlous fiscal position,” Rachel Ziemba, managing director of emerging market research with 4CAST-RGE said. “This increases the risk of greater cuts overall, which might lead to a more expansive fiscal and monetary stance.”
Any failures on the part of Brazil’s Congress to pass the economically crucial pension reform (as seems increasingly likely) and limited fiscal measures would keep the fiscal stance more expansive and limit the decline in the real interest rate.
With political drama set to kick off again soon when Congress returns, there is concern that investors are being well paid for Brazilian risk.
“It may take both local and external catalysts for any reversal,” Ziemba said.