MNI INTERVIEW: BCB To Keep Rates High For Longer -Le Grazie

The Central Bank of Brazil is likely to maintain its Selic official rate at 10.50% until the end of 2025, former deputy governor for monetary policy Reinaldo Le Grazie told MNI, adding that despite currency weakness and political noise there is little market pressure for higher borrowing costs.

"I think it is the 'higher for longer' strategy. I believe the pressure from the market to increase interest rates is low at the moment. None of the members are considering rate hikes. Next year's direction will hinge on government actions," Le Grazie, now a partner at fund manager Panamby Capital, said in an interview. (See MNI INTERVIEW: Hawkish Copom Hints At Prolonged Hold-Kawall)

The Brazilian real faced extreme volatility this week, hitting a low point of 5.68 to the dollar on Tuesday, as President Luiz Inacio Lula da Silva attacked the central bank for keeping rates high and cast doubt on his government's willingness to cut costs to achieve a fiscal deficit target of zero for 2024 and 2025. However, by Thursday, the real strengthened to 5.49 following the announcement by Finance Minister Fernando Haddad, after a Wednesday night meeting with Lula, of a BRL10 billion budget spending freeze this year and BRL25.9 billion in cuts for 2025.

FISCAL MEASURES

"The fiscal measures announced were well received, and the market responded positively. The decision to allocate BRL10 billion for budget contingencies seems feasible," said Le Grazie. "It represents a shift from the government's confrontational stance, particularly from President Lula, which is a good signal. However, it is just the first battle.”

Partly thanks to the weaker currency, Le Grazie expects inflation to rise, and to finish the year close to 4.5%, up from 3.9% in May and just at the edge of the central bank’s 1.5-percentage point tolerance band around its 3% target.

"Food prices have stopped falling and several pressures are emerging, such as the exchange rate. The exchange rate is expected to contribute an additional 30 basis points to inflation this year," he said.

Asked about the future path of the real, which traded around 5.00 to the dollar throughout the first quarter, Le Grazie did not give a precise guess.

"I have no idea, but we're observing a dollar equilibrium around BRL5. If conditions normalize, we could expect a return to that level."

The Central Bank of Brazil kept borrowing costs steady last month for the first time after nearly a year of aggressive easing. The unanimous decision by monetary policy committee Copom contrasted with the split vote for a 25-basis-point cut in May, when four members called for a 50-basis-point reduction. (See MNI INTERVIEW: Brazil's Copom On Hold Until December - Kfoury)

Le Grazie said the central bank has been right not to intervene to prop up the currency.

"The crisis doesn't justify it. The dollar is stronger abroad, and you can't fight against the dollar. The difference compared to our peers was domestic. Therefore, it's best to wait for a domestic solution to appear," he said.

As former head of monetary policy, Le Grazie was responsible for determining FX market interventions. Currently, that position is held by Gabriel Galipolo, who was nominated by Lula and is considered favorite to succeed Governor Roberto Campos Neto when his term ends on Dec 31.