Brazil starts 'shortest and smallest' tightening cycle
The Brazilian central bank raised its key interest rate but analysts say this tightening cycle will the shortest in history
The Brazilian central bank's Monetary Policy Committee (COPOM) raised the Selic rate by 25 basis points to 7.5%, less than some market expectations which called for a 50 basis points hike, to fight rising inflation.
Analysts say this signals a soft tightening cycle ahead, with the central bank still worried that it might hurt the fragile economic growth.
The decision "suggests that the tightening cycle is likely to be less aggressive than many seem to expect," Neil Shearing, chief emerging markets economist at Capital Economics, said.
"In fact, we think it will be the shortest and smallest tightening cycle in history."
Shearing says that policymakers in Brazil seem to have done "the bare minimum" necessary to reassure investors that they were committed to inflation targeting.
He noted that two COPOM members voted to leave the rate unchanged, inflation's hike might be temporary as food inflation caused by weather-related factors "should start to fall back," and policymakers still have to "balance inflation concerns against the continued weakness of economic growth."
"With elections approaching next year, political pressure to stimulate growth will only intensify," Shearing said.
He estimates that the Selic rate will only rise to 8% during this tightening cycle, against market expectations of 8.75% by the end of the year and 9.25% by mid-2014.
Enestor Dos Santos, an analyst with BBVA, expects three more 25 basis points cuts in the Selic rate over the next three monetary policy meetings (in May, July and August) although he admits that "the last of these three hikes could be aborted as by then we expect inflation pressures to ease somewhat."
'WIDESPREAD' INFLATIONARY PRESSURES
Dos Santos notes that, with price rises currently exceeding the 6.5% ceiling, inflationary pressures "are widespread" and "inflation expectations are not well-anchored," so the decision by the central bank to start monetary tightening "should be seen as good news."
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But it comes at a cost. It should have a negative, albeit small, impact on economic growth and on credit markets, and it could put upward pressure on the exchange rate, which could end up sparking more measures to prevent the Brazilian real (BRL) from appreciating sharply, Dos Santos said.
"Taking into account these costs, the natural dovishness of this BCB board and our perception that this cycle will be adopted to anchor medium-term inflation expectations around 5.5% (and not to drive domestic demand down in order to guarantee that inflation converges to the 4.5% target) we expect this monetary tightening cycle to be relatively soft," Dos Santos wrote in a market note.
Some analysts believe that the cautious move may cost the central bank its credibility in fighting inflation.
"While a more cautious approach at the start of the tightening cycle suggests the BCB is going for the smallest budget of hikes, the reality is that the BCB missed the opportunity to deliver a positive shock that would have helped restore some credibility in its reaction function while containing inflation expectations," Flavia Cattan-Naslausky, a strategist with RBS, wrote.
She believes the decision is negative for Brazilian assets, "as it further feeds into the view of weak overall policy" and could even lead to a depreciation of the Brazilian real.
"While short-term the outlook is for BRL appreciation on capital market flows, beyond the short term, we look for a weaker BRL back up above 2.000 [versus the US dollar]," Cattan-Naslausky said.
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