MNI INTERVIEW: No BCB Rate Hike Ahead, 2025 Cut Likely-Kanczuk

The Central Bank of Brazil is signaling that it has no intention to hike rates again in future meetings and is likely to start cutting rates at the end of this year, especially if inflation starts to fall and activity weakens, former BCB deputy governor for economic policy Fabio Kanczuk told MNI.

The central bank’s message about keeping interest rates high for an extended period aims to curb bets on premature cuts in the yield curve, Kanczuk said, adding that the fact that it raised rates by 25 basis points to 15% at the last meeting while signaling an interruption in the cycle implies little willingness to resume hiking.

“I find it strange that the Copom hiked and then said it’s done. For some reason, the committee believes rates are already very high, but at the same time, they’re concerned about the curve because long-term rates are what really impact the economy,” Kanczuk, now head of macroeconomics at ASA Financial Institution, said in an interview.

“In practice, they raised by 25bp but announced the interruption, which canceled out the tightening effect of the hike. It’s a signal that if you’re having such a hard time hiking further, it’s because you’re actually eager to cut,” he added.

BEST MONETARY STRATEGY

The former deputy governor said the best strategy would have been to hike without declaring the end of the cycle and to commit to cutting only if certain conditions are met, such as current inflation being close to 3%, expectations remaining anchored, or unemployment rising above 8%, for example.

The minutes had a more dovish tone, he noted, with subtle hints suggesting a high level of confidence that the tightening job is done. (See MNI INTERVIEW: BCB To Hold Rates At 15% Until Next Year- Velho)

The fiscal section in the minutes also sounded "somewhat odd."

“They said that discussions about eliminating tax expenditures and raising revenues could help reduce risk premiums and improve the effectiveness of monetary policy. Maybe that’s a way of supporting the finance ministry, but it could also come across as overly optimistic about the possibility of increasing the tax burden, which is unlikely to happen,” he said.

LOW NEUTRAL RATE

The Monetary Policy Report (RPM) numbers were quite striking, Kanczuk stressed, particularly the assumption of a 5% neutral rate, which he called “very low.”

“I think it’s 8%, and market consensus is closer to 6%. If the neutral rate is really that low, the Selic would have been highly contractionary for quite some time already, and economic activity should be slowing down. But if the central bank truly believes that, it means they see the current rate as extremely high.”

Another inconsistency pointed out by Kanczuk is the output gap calculated by the central bank, which narrowed from 0.9% in the first quarter of this year to 0.5% — a significant change in a short period.

“That creates another problem for their forecasts because if the neutral rate is 5%, monetary policy is extremely tight, and inflation falls sharply in their model. That would mean they should start cutting at the next meeting. So to make the projections fit, they need to force the output gap to jump significantly from one quarter to the next to maintain consistency,” he said.

BCB CUTTING THIS YEAR

In his view, Copom might start cutting rates by the end of this year. “I don’t think inflation needs to fall much for them to begin reducing. It’s enough if economic activity stops growing so strongly, and I think there’s a reasonable chance of that.”

“Another possibility is the Fed starting to cut, which could give the central bank enough confidence to begin the easing cycle here as well,” he added.

He emphasized that the BCB is facing a credibility issue. “I think it’s already clear that they’re not aiming for the 3% target. If they really wanted to bring inflation to target within the relevant horizon, they would have to raise rates further.”