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Despite explicitly guiding markets to a final 50bps cut in May at its March meeting, the BCB yesterday reneged on this guidance by cutting the Selic rate by 25bps to 10.5%.
This marks the first deceleration in the BCB’s easing cycle since it began cutting rates in July. As we noted in our preview, the decision to cut rates by 25 basis points or 50 was finely balanced. On the one hand, inflation had on an aggregate basis continued to decelerate, supporting the BCB’s March guidance. While on the other hand, services inflation remained hot, external inflation conditions marginally deteriorated, and fiscal developments posed greater risks of inflation persistence. While we expected the BCB to deliver on its forward guidance due to the positive progression of headline inflation and to retain credibility, ultimately the majority of the Copom determined that the upside risks to inflation were too prominent, specifically due to the announcement of more expansionary fiscal policy since March. Although not explicitly highlighted in the accompanying statement, this division was visible in the vote split, which saw the Copom vote 5-4 in favour of a slower pace of easing, with the four dissenting members all appointed by the current government. Looking ahead, we think the latest BCB decision underscores the rising risks of the BCB clashing once again with the pro-growth Lula administration.
Given how damaging the period of strained tensions between the executive and central bank were back in 1Q23 to investor sentiment, we suspect these risks will limit the extent to which BRL can appreciate in the coming months, even as a more hawkish BCB supports the real’s carry profile. This has been evidenced at the open of Brazilian markets this morning, where the real has opened under renewed pressure as investor sentiment has soured on the prospect of another public feud.
Until now, a defining feature of the BCB’s stance, beyond caution or a vigilant approach, has been unanimity in its decisions. For the past ten months, all nine members of the BCB’s Copom had agreed that the pace of monetary policy easing should be 50 basis points when considering the balance of risks to inflation and the evolution of the data. However, at the March meeting we found an interesting shift in explicit guidance when Copom went from anticipating cuts of the same magnitude, in the plural, to anticipating “a reduction of the same magnitude at the next meeting” if the Bank’s expected scenario is confirmed. In our view it was precisely this last point, the “Bank’s expected scenario”, that has not been fulfilled. After the BCB has maintained the pace of its easing cycle during the first quarter of 2024, since March, the progress of talks on more expansionary budgets on the expenditure side between the government and the representative chambers in charge of approving the new fiscal framework has undermined the Bank’s balance of risks. This was highlighted in the BCB’s rate statement through the discussion of the risks to the possible de-anchoring of inflation expectations and thus to monetary policy from a fiscal policy not committed to debt sustainability. In light of these risks, and after holding its forecasts stable in March, the BCB revised up its baseline scenario for inflation from 3.5% to 3.8% for 2024 and from 3.2% to 3.3% for 2025.
Despite the April meeting being notable for the divergence of views among Copom members, the statement showed that the cautious view on the global and domestic outlook is unanimous, and that the extent of the next rate adjustments will be dictated by the firm commitment to the convergence of inflation towards the target.
In our view, this should limit risks ahead of the June meeting, where most members should align with previous guidance and deliver a further 25 basis point cut. However, given that three of the five members who voted in favour of 25 basis point cut at the May meeting end their term of office at the end of this year, including President Campos Neto, last night’s split could pose risks to decision making moving forward. Consequently, while we anticipate that the BCB’s more cautious stance could support the Brazilian real towards the psychological 5.00 level over the medium-term as the Fed begins to cut from Q3, this is unlikely to transpire as long as the independence of monetary policy remains at risk. This risk will be especially pronounced if the government’s spending plans exceed its borrowing limits, as it would not only risk the BCB abandoning its easing cycle, which would certainly cause friction with the government and risk outright political interference, but would also risk undermining investor sentiment on the basis of Brazil’s debt sustainability. If this were to happen, the real’s trading range would likely move significantly away from current levels and probably from those seen over the past 18 months.
The Brazilian real opens under pressure as investors become wary of another clash between the BCB and the Lula administration
Author:
María Marcos, FX Market Analyst