Brazil's central bank hikes base rate again amid contradictory signals

Amid contradictory signals, the Brazilian central bank increased the Selic base rate to 14.25% from 13.25% on Wednesday night and indicated there will be at least one more hike ahead, to be announced May 7.

"In light of the continuation of the adverse scenario for inflation convergence, the high level of uncertainty, and the inherent lags in the ongoing monetary tightening cycle, the [central bank policy] committee foresees, if the expected scenario is confirmed, a smaller adjustment in the next meeting," the bank said in a statement.

"Beyond the next meeting, the committee reinforces that the total magnitude of the monetary tightening cycle will be dictated by the firm commitment to inflation's convergence to the target," it added.

Wednesday's increase was the fifth consecutive rate hike, and the Selic is now at its highest since 2016, when Brazil was in political and economic turmoil amid the impeachment of then-president Dilma Rousseff.

Inflation reached an annual level of 5.06% in February, above the central bank's target of 4.50%.

Economists expected that the successive interest rate hikes since mid-2024 would rein in inflation through a cooling of the economy.

However, so far, the economy, which grew 3.4% last year, has shown signs of overheating, while a record agricultural harvest expected for this year could generate further growth.

"It's difficult to make a prediction about interest rates, but I project at least one more increase in the Selic rate at the next meeting, to 14.5%, with the rate remaining at that level over the next few months," Roberto Troster, former chief economist at banking federation Febraban, told BNamericas. 

"We have seen in recent months the appreciation of the Brazilian real against the US dollar, which will generate less pressure on food prices, but I recognize that there are other factors counteracting the price pressures. For this reason, many economists expect interest rate hikes larger than mine." 

Adding uncertainty to inflationary pressures, this week the Luiz Inácio Lula da Silva administration requested authorization from congress to increase the tax exemption threshold to 5,000 reais (US$883) a month, compared to the current 2,824 reais. If approved, the measure will take effect in 2026.

To compensate, the government is proposing taxes on individuals who earn more than 50,000 reais a month. In Brazil, many high-income individuals manage to bypass paying taxes by receiving their income through dividends from companies instead of salaries.

"It will add more economic stimulus to the economy ahead of the late 2026 elections. Given that the economy is operating with a positive output gap and given a number of other recent fiscal and quasi-fiscal measures to support credit and household income, we expect the measures to support consumption spending but also to contribute to keeping inflation high and above target, forcing the central bank to keep a tight, restrictive monetary stance for longer," said Alberto Ramos, an economist at Goldman Sachs, in a research report.

Lula, who has seen his approval ratings steadily decline in recent months, wants to use the threshold increase to gain the support of the middle class in his attempt to win reelection in October next year.

The contradictory economic signals have even confused the government. The finance ministry, in its quarterly fiscal macroeconomic report, maintained the forecast for GDP growth for this year at 2.3%, while Lula offered a different view.

"Experts say that Brazil won't grow much in 2025. I want to challenge this. Brazil will grow again above 3%. The economy will improve and grow more because we will provide a lot of credit for small and medium-sized entrepreneurs," Lula said in a televised speech later Wednesday.

Amid the uncertainty and inflationary pressures, interest rates are expected to remain high, at least in the medium term. 

"I don't see interest rates in Brazil entering a consistent downward trajectory until at least mid-2026, and that is quite negative for companies' intentions to raise funds through the capital market," Alexandre Pierantoni, head of corporate finance and M&A at Kroll, told BNamericas.