Brazil: COPOM cuts key interest rate further in May; suggests one more cut on the horizon
At its 5–6 May meeting, the Central Bank of Brazil’s Monetary Policy Committee (COPOM) unanimously voted to cut the benchmark SELIC interest rate from 3.75% to a fresh record low of 3.00%. This meeting’s reduction was larger than the rate cut penciled in by a majority of market analysts.
The Bank signaled its commitment to buttressing the economy as best as possible against the Covid-19 crisis, by cutting the key policy rate for the seventh consecutive meeting in May. COPOM now foresees a sharper economic contraction than it had forecast in its previous meeting as the pandemic deals a harsh blow to the global economy; commodity prices are undergoing a severe downward correction; and capital outflows have intensified significantly.
Turning to inflation, COPOM expects inflation to come in around 2.4% at the end of 2020 and 3.4% for the end of 2021, based on a hybrid scenario with a constant exchange rate of BRL 5.55 per USD; the SELIC rate ending 2020 and 2021 at 2.75% and 3.75%, respectively; and with Brent oil prices rising about 40% by the end of 2020. Inflation is thus expected to notably undershoot the Bank’s inflation target of 4.0% for 2020. The Committee continues to view the risks to the inflation outlook as fairly balanced: Downward pressures will stem from economic slack, particularly if the pandemic is prolonged, whereas upward price pressures could arise from the government’s fiscal response and delayed reforms increasing risk premiums.
In its forward guidance, the Bank signaled it would further unwind its policy this year, commenting that “the current state of affairs recommends an unusually large monetary stimulus”. The Bank, however, also stressed that a sidelined fiscal consolidation agenda could provoke higher-than-expected inflation or result in a higher structural interest rate, which would limit COPOM’s space for additional adjustments. Consequently, the Bank stated that, conditional upon the fiscal path and incoming economic data, COPOM would consider another, final, rate cut at its upcoming meeting on 4–5 June.
The Brazilian real depreciated markedly on the Bank’s decision and reached a new all-time low of 5.72 on 6 May.
Commenting on the implications of the meeting, Alberto Ramos, Latin American economist at Goldman Sachs noted:
“At this stage, given the decisive guidance we believe that no cut at the next meeting is unlikely and based on the guidance and overall language of the statement we are of the view that a -50bp or -75bp cut are roughly equally likely, with risk perhaps slightly skewed towards a-50bp. […] Overall, Brazil is moving rapidly towards a zero real rates uncharted financial territory. The economy never operated in such an environment. It may turn out that the new territory is market friendly and hospitable, but we do not know until we operate there for a bit.”