UPDATE 2-Brazil hikes rates by most in 18 years, vows to go past 'neutral' to tame inflation

Jamie McGeever
Updated ·2 min read

(Adds economist quote, context)

By Jamie McGeever

BRASILIA, Aug 4 (Reuters) - Brazil's central bank raised its key interest rate by a full percentage point on Wednesday for the first time since 2003, and pledged to step on the policy tightening accelerator even harder to ensure inflation is pulled back toward target next year.

With 2021 inflation running significantly above the central bank's mandated target range this year, policymakers said they stand ready to raise borrowing costs beyond the so-called 'neutral' rate to make sure its 2022 and 2023 goals are met.

The unanimous decision to raise the benchmark Selic rate to 5.25% was in line with the predictions of 37 of the 46 economists in a Reuters poll, and followed three consecutive rate increases of 75 basis points.

Economists estimate the current neutral rate translates to a Selic rate of about 6.5%, and Copom said it expects to deliver another rate increase of 100 basis points at its next meeting on Sept. 21-22.

"At this moment, the Copom's baseline scenario and balance of risk indicate as appropriate a tightening cycle of the policy rate to a level above the neutral," the central bank's rate-setting committee known as 'Copom' said in its accompanying statement.

Rafaela Vitoria, chief economist at Banco Inter in Belo Horizonte, said the pledge to raise rates beyond the neutral rate will help put the brakes on economic growth and boost the exchange rate, both of which should cool inflation.

"The statement made it very clear that Copom is worried about inflation, which has been much more persistent than expected, especially in the services sector," Vitoria said.

"They are worried about 2022 inflation expectations becoming un-anchored," she added.

A neutral policy rate is the level of interest that promotes full employment and maximum economic output without fueling inflation. In Brazil, economists reckon the neutral rate is around 3% in real terms, meaning a Selic rate of around 6.5% assuming the central bank meets its 2022 inflation goal of 3.5%.

Copom said its baseline scenario forecasts inflation of around 6.5% this year, 3.5% next year and 3.2% in 2023. This scenario assumes a Selic rate of 7.00% at the end of this year and all of 2022, dropping to 6.50% in 2023, it said.

Copom said inflation has been persistent and its composition has deteriorated. In particular, it noted a surprising increase in services price pressures and industrial goods inflation, which are raising core inflation measures.

Copom also highlighted new "volatile" inflation components, such as potentially higher electricity fares and food prices due to adverse weather conditions in Brazil right now.

"The Committee understands that, at this moment, the strategy of a quicker monetary adjustment is the most appropriate to guarantee the anchoring of inflation expectations," it added. (Reporting by Jamie McGeever; editing by Stephen Eisenhammer and Richard Pullin)

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