MNI INTERVIEW: BCB Likely To Cut 50BP Despite Conflict - Velho

The Central Bank of Brazil is likely to cut its official Selic rate by 50 basis points this month to 14.50%, though the possibility of 25-basis-point reduction is gaining traction within the BCB as the Iran war sends oil prices higher, former economic advisor to the Ministry of Planning and Budget Eduardo Velho told MNI.

“The central bank cannot make short-term decisions based on a supply shock. It has to look at what we call the secondary effect, that is, the indirect transmission of the shock to prices,” Velho, now chief economist at Equador Investimentos, said in an interview.

Policymakers will have to make a judgment as to the potential duration of the conflict as they weigh the impact of this supply shock, he noted.

The economist mentioned that the market is already pricing in a higher probability of a 25bp cut and has reduced the probability of a 50bp move.

"So it is very likely that the Selic rate in the BCB Focus market survey will be adjusted slightly upward. It may already have moved higher and the BCB will capture that over the course of this week. This could have an immediate impact on the central bank’s inflation projections, the question is whether it will be significant or not. I don’t think so," he said.

The BCB decided in January to hold the Selic rate at 15.00% once more and said it would start the easing cycle at its next meeting in March if the outlook evolved as expected, without specifying the size of the cut.

EXCHANGE RATE KEY

Velho added that the exchange rate will be key for the next decisions by monetary policy committee Copom. (See MNI INTERVIEW: BCB Likely To Cut 50bps In March - Megale)

"So far there has not been a major rush into the dollar. It even reached BRL5.28, but moved back to the range closer to 5.20, 5.25. There is not really a movement that would generate a strong appreciation of the dollar in the short term,” he said.

Copom would only change its flight plan if the dollar rose above the level used as the baseline for the previous meeting in January, of BRL5.35, according to Velho.

"If there were a very strong depreciation of the real, it would open a significant risk not only of cutting by just 25bp but even of keeping rates unchanged. But that is not the case," he said.

State oil company Petrobras is unlikely to make sharp adjustments to gasoline prices based on conflict-driven prices, which in the short term are speculative, Velho said.

"Apparently there is no outflow of funds into the dollar. On the contrary, there is no rush of capital leaving Brazil. Brazil still appears to have a favorable external backdrop. International reserves are already around USD370 billion."

CUTTING TO BELOW 12%

He believes Copom will cut interest rates to slightly below 12% this year, given that the neutral rate is around 6%.

Inflation should continue on a downward path. Though it will not reach the 3% target, it should remain slightly below 4% in 2027, even with interest rates possibly below 12%, Velho said.

In this scenario, the central bank would not need to strictly pursue the 3% target and could operate within its tolerance band, allowing inflation of around 3.7% to 3.8%, especially in the face of supply shocks, he said.

He also noted that, unlike in past crises, global demand for dollars has been lower, with investors seeking other assets, which tends to reduce inflationary pressures in Brazil.