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UPDATE 2-Brazil's central bank sees little room to cut rates, recommits to inflation goals

(Adds details from minutes, comment)

BRASILIA, June 23 (Reuters) - Brazil’s central bank sees little scope to reduce interest rates much further, even though inflation is running well below target and the economic shock of the coronavirus pandemic is disinflationary, minutes from its latest policy meeting showed on Tuesday.

The current record low official interest rate of 2.25% is considered “close” to the level from which further cuts could fuel financial market instability, the minutes from the June 16-17 policy meeting said, underscoring the delicate debate surrounding the so-called ‘effective lower bound’ for rates.

With inflation significantly below this year’s 4.0% target and set to undershoot next year’s 3.75% target, however, policymakers also stressed their commitment to meeting their inflation goals, minutes of the meeting showed.

Up until May’s meeting of the bank’s rate-setting committee, known as Copom, policymakers did not see the need to include such a commitment in any set of minutes since Roberto Campos Neto took over as bank president early last year.

“A preliminary reading of the minutes suggests that the Selic is above the appropriate level to achieve the bank’s inflation target,” said Jose Francisco Goncalves, chief economist at Banco Fator in Sao Paulo, referring to the central bank’s benchmark rate.

With Brazil’s economy heading for its biggest annual economic decline on record amid subdued inflationary pressures, Copom’s 75-basis-point cut the Selic last week was in line with expectations and unanimous.

Copom said last week that any further reduction would likely be “residual” and “small”. The minutes released on Tuesday reaffirmed that sense of caution, even though inflation expectations are falling “towards levels not compatible with the target, particularly, within the relevant horizon for monetary policy.”

Most Copom members said the so-called effective lower bound for rates is not only significantly higher in emerging economies, but that the risk premium in Brazil is even higher given the country’s fiscal fragility.

“In this context, we would already be close to the level from which further interest rate reductions could be accompanied by asset price instability,” the minutes said.

The minutes showed that as well as watching economic and inflation indicators closely, Copom noted that developments on the fiscal and COVID-19 fronts will be “essential” to its next steps.

On the economy, policymakers said the decline in the first half of the year will be steep, with the recovery starting to pick up from the third quarter onwards, the minutes said. (Reporting by Jamie McGeever; Editing by Andrew Heavens, Steve Orlofsky and Paul Simao)