Brazil central bank hikes rates, eyes quicker return to ‘neutral’ policy

FILE PHOTO: The central bank headquarters building is seen in Brasilia
The central bank headquarters building is seen in Brasilia, Brazil May 16, 2017. REUTERS/Ueslei Marcelino

SAO PAULO, June 16 (Reuters) - Brazil’s central bank delivered its third consecutive interest rate increase of 75 basis points on Wednesday and raised the specter of larger hikes ahead as it returns to “neutral” rates, dropping plans for a “partial” normalization of policy.

With economic growth much stronger than many had expected and inflation forecast above the central bank's mandated target range this year, policymakers signaled that rates are likely to be raised higher and perhaps more quickly than previously planned.

Wednesday's decision to raise the benchmark Selic rate to 4.25% was exactly as central bank officials had indicated and all 37 economists in a Reuters poll had predicted.

But with inflation running well above target this year and threatening to unmoor expectations for next year, the big shift came in the accompanying statement.

"At this moment, the Copom's (monetary committee's) baseline scenario indicates, as appropriate, a normalization of the policy rate to a level considered neutral," policymakers wrote in their decision, axing mention of "partial" normalization made in prior months.

"For the next meeting, the Committee foresees the continuation of the monetary normalization process with another adjustment of the same magnitude. However, a deterioration of inflation expectations for the relevant horizon may require a quicker reduction of the monetary stimulus," they 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 6.5% assuming the central bank meets its 2022 inflation goal of 3.5%.

"The most hawkish point in the statement is the neutral rate, that they will go straight to the neutral rate," said Jose Francisco Goncalves, chief economist at Banco Fator in Sao Paulo.

"But I think it will be higher ... if they don't want to fall behind the curve, they could go to 7.00%," he said.

Twelve-month inflation is running at 8.1%, well above the central bank's 2021 goal of 3.75% and even the 5.25% upper limit of its target range. Surveys show 2022 inflation expectations now drifting above the bank's 3.50% goal for next year.

Copom said its baseline scenario is for inflation to end this year at 5.8% and next year at 3.5%. Central bank chief Roberto Campos Neto said this month that the bank was "100% committed" to meeting its inflation goals.

A sharp rally by the Brazilian real in the last three months has helped to ease price pressures. But the stronger currency has been outweighed by recovering economic activity, hopes that a pickup in vaccinations will accelerate growth and, recently, fears that a severe drought will boost energy prices.

Copom said raising the Selic towards the neutral rate is necessary to prevent what it considers temporary price shocks from creating broader inflationary pressures.

“However, the Committee again emphasizes that there is no commitment with this plan, and that future steps of monetary policy could be adjusted to assure the achievement of the inflation target,” it said.

Reporting by Jamie McGeever Editing by Brad Haynes

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Jamie McGeever has been a financial journalist since 1998, reporting from Brazil, Spain, New York, London, and now back in the U.S. again. Focus on economics, central banks, policymakers, and global markets - especially FX and fixed income. Follow me on Twitter: @ReutersJamie