Brazilian Central Bank not done hiking yet

Summary

We are adjusting our outlook for the Brazilian Central Bank (BCB), and now forecast one last 25 bps rate hike to be delivered at the June Copom meeting. We view the balance of risk as between a hike or a hold, but we ultimately believe elevated inflation and fiscal concerns are enough to prompt one last BCB hike before policymakers embark on an extended pause. Attractive carry can anchor the Brazilian real in the near term; however, we remain of the view that the intersection of local politics and fiscal policy can drive the Brazilian real to all-time lows against the dollar by the middle of next year.

Following the Brazilian Central Bank's (BCB) May monetary policy meeting and subsequent policymaker commentary we are making slight adjustments to our Selic rate forecast. To that point, we now believe the BCB Selic rate will peak at 15.00% as opposed to a prior forecast of 15.25%. In our view, a 25 bps hike at the June meeting is the most probable outcome—significantly more likely than our previous forecast calling for a 50 bps hike and slightly more likely than policymakers keeping monetary policy settings on hold. Our view for an additional 25 bps hike rather than a hold stems from local inflation that is above the upper bound of the central bank's inflation target as well as lingering fiscal concerns. The CPI has moved almost a full percentage point higher over the first few months of this year despite a stronger Brazilian real, broadly lower energy prices and fairly restrictive monetary policy settings. We believe policymakers will take the next meeting as an opportunity to continue defending against inflation that is trending in the wrong direction and attempt to anchor inflation expectations. Elevated inflation is a product of resilient economic activity, with solid economic momentum a derivative of loose fiscal policy over the course of Lula's administration. While spending cuts have materialized over the past few months, recent headlines suggest Lula may be planning more social spending. Brazil has been teetering on the brink of fiscal dominance, and in our view, policymakers will feel a need to be proactive and defend against another large BRL selloff should fiscal slippage unfold. While we have scaled back the degree of BCB tightening, we continue to believe policymakers will exhibit caution when considering a pivot to rate cuts. Our Monetary Policy Space Framework suggests BCB policymakers can lower rates by the end of this year; however, fiscal concerns lead us to continue to forecast the easing cycle to start in early 2026.

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