Preceded by lower-than-expected inflation earlier in the day, the decision by the Brazilian central bank to cut interest rates by 75 basis points (bps) instead of the 50 bps forecast was a surprise that had been a while in the making.
Activity has been consistently weaker than both the market and central bank had predicted, even in the context of a struggling economy, and the rate cut at the previous meeting had been a mere 25 bps, half of what most economists had called for.
So in many ways this more aggressive move rectifies an earlier mistake. The central bank’s earlier caution seems to have been overwhelmed by a raft of weaker data.
Though improving, retail sales and industrial production both point to an economy which is still in contraction. Fortunately for the central bank, this soft activity means inflation pressures are also ebbing.
Will Brazil cut interest rates further?
Headline inflation is now below the upper band of the target for the first time since December 2014. The bank’s own forecast for inflation has now been revised down to 4.4% this year, implying scope for greater cuts than priced by the market.
This means we could see the rate cut below 10% this year, implying at least another 300 bps in cuts.
The aggressive easing will be welcomed by corporates and households who continue to strain under high debt service burdens, but it is unlikely to prompt much releveraging just yet.
While commercial banks have already eased rates in line with the central bank’s decision, unemployment continues to grow and will do so even for some time after GDP recovers.
There is also a risk that growing political uncertainty weighs on business confidence and hence capital expenditure. For now, we leave our GDP growth forecast unchanged for 2017, at a rather anaemic 0.6%.
The articleabove by Craig Botham, Emerging Markets Economist at Schroders, was first published by Schroders on 12th January 2017.