Economic Analysis - Rate Hikes Finished As Pension Reform Appears Unlikely - APR 2018

BMI View: The Banco Central do Brazil will hold interest rates steady over the coming quarters as inflation trends higher and the prospects for pension reform fade.

  • The Banco Central do Brasil (BCB) will most likely hold its benchmark Selic rate at 6.75% through end-2018.
  • Inflation will remain within the bank's target range but trend higher over the coming months, underpinned by rebounding domestic demand and higher average energy prices.
  • Additional rate cuts could be triggered if pension reform is passed, although the probability of passage is falling.
Rates Likely On Hold As Inflation Rises
Brazil - Inflation & Policy Rate
Source: IBGE, BCB, BMI

The BCB's 25 basis point (bps) rate cut on February 7 was most likely the end of its rate cutting cycle. Between October 2016 and February, the bank cut its benchmark rate a cumulative 750bps, to a record-low 6.75%, in line with our view ( see 'Rate Cuts Not Quite Finished', December 7 2017). The bank's forward guidance stated its intention to hold rates moving forward amid rising inflation and the diminishing probability of pension reforms, which are needed to ensure fiscal sustainability and by extension structurally lower inflation ( see 'Downside Risks To Fiscal Sustainability Rising', December 14 2017).

Inflation will pick up over the coming months, although it will remain within the BCB's 2.75-5.75% target band. Inflation slowed modestly in January to 2.86% y-o-y, from 2.95%, reflecting contained food prices and housing costs. Over the coming months, rebounding domestic demand, supported by lower interest rates, rising oil prices and a weaker exchange rate will push inflation to 3.69% by end-2018. On an annual average basis, inflation will be flat at 3.50%, from 3.46% in 2017.

The BCB could cut rates further in 2018 if pension reforms are enacted. Fiscal reforms are central to the bank's outlook, as wide deficits have driven inflation over recent years. Pension reforms are needed to manage the growth of compulsory spending and ensure the gradual narrowing of the deficit, but the likelihood of passage is falling ( see 'Policy Uncertainty Coming To The Fore ', December 15 2017). Although President Michel Temer's administration continues to push for a modest reform bill, it remains well short of the votes needed to pass the legislature, due to Temer's rock-bottom approval, fracturing coalition and the impending general election campaign. If Temer is able to pass reform, the BCB could enact additional cuts, but we do not expect any more than an additional 25bps cut.