MNI INTERVIEW: BCB Might Cut Sooner as Activity Slows - Serra

Brazil’s economy is likely to weaken more sharply than expected with real interest rates already at 10%, dampening inflation and possibly prompting a shift to rate cuts by the end of this year or early 2026, former Central Bank of Brazil deputy governor for monetary policy Bruno Serra told MNI.

"With a real interest rate of 10%, in a normal cycle, we should be worried about a recession, not inflation. But everyone is very concerned about inflation, as reflected in expectations," Serra, now a portfolio manager for the "Janeiro" fund family at Itau Asset, said in an interview.

The BCB is likely to hike by 50 basis points at its next meeting in May, he noted, while the June meeting remains "open," with a possible final tightening move of 25bp. The BCB’s Copom committee hiked its Selic rate by 100 basis points again this month to 14.25%, taking rates to 10% in real terms based on 12-month inflation expectations, according to Serra.

"For May, the minutes leave multiple options open. Copom could hike by 25 to 75 basis points at the next meeting. But honestly, a 75bp hike is not credible. The most likely scenario is a 50bp increase, with some chance of 25bp," he said.

"If I had to pick an alternative scenario, it would be 25bp rather than 75bp. And June is entirely open, it may not hike at all. But my baseline case is another 25bp hike in June." (See MNI WATCH: BCB To Slow Hiking Pace, Magnitude Still Uncertain) 

Janeiro fund forecasts inflation closer to 5% for all of 2025, compared to the consensus of 5.65%, implying that rate cuts will come sooner, according to Serra. He is also more optimistic about the exchange rate, as U.S. policy points to a weaker dollar, while Brazil’s domestic conditions support a stronger real. (See MNI: Independent CenBanks Reduce Inequality - BCB Advisor)

FISCAL OUTLOOK

Exceptionally strong monetary tightening has been unaccompanied by significant fiscal expansion as seen previously, he noted.

"This year, real government spending is expected to decline by about 2%, adjusted for inflation. That’s a contraction in public spending growth even larger than during the spending cap period." 

At the same time, a major driver of GDP is agriculture, which tends to ease inflationary pressure, he said.

"Each increase in our harvest translates directly into export momentum and lower food prices in Brazil. So, GDP dynamics are actually positive for the central bank,” said Serra.

"I’d say that by the end of this year, we’ll already be discussing rate cuts. At the May meeting, Copom will be looking at 12-month inflation for Q4 2026, which should be around 3.6%, closer to the 3% target.”

APART FROM CONSENSUS

The BCB could start cutting in the last quarter of 2025, with more significant cuts early next year, he said, adding that any shift to market optimism about Brazil’s 2026 elections would find plenty of room for easing in the first half of next year, possibly bringing the Selic back near 10%.

"If markets remain concerned about the transition, the easing cycle could be more cautious. Right now, the market is betting entirely on the negative scenario, but I see significant upside risks," Serra said.

From the second half of this year, the BCB board will start focusing on Q1 2027 inflation, which should be around 3.3%, he noted.

"When we raised rates to 13.75% in the last tightening cycle, it was very close to nominal GDP, which is historically normal. Today, nominal GDP is at 7.5%, while the Selic is going to 15%, double the level. The only time we saw this kind of gap was during the 2015 recession, and what happened to inflation after that? It fell below 3%," Serra said.

The central bank began hiking aggressively in December, and Serra noted that monetary policy operates with a lag of around four quarters.

"The effects will start to become visible in Q3, and that’s when monetary policy will begin to weigh on the economy,” he said.