End in sight for Brazil’s easing cycle

Brazil cut rates as expected to 7.5% from 8.25%, a slight reduction in the pace of easing this cycle. An accompanying statement suggested further slowing of easing from here.

Inflation low but creeping higher

While inflation remains very low by historic standards, it is beginning to creep higher, reaching 2.5% in September, and growth is also making a modest recovery. Against this backdrop, and in the context of an easing cycle which has delivered 675 bps of cuts in the last year, some policy caution seems justified. A reduction in the pace of easing will likely see a 50 bps cut in December.

Central bank may end easing cycle in December

The central bank’s inflation target remains 4.5%, and it expects this to be reached in 2018 and 2019. With policy rates at 7% following a December cut, this would mean real rates of 2.5%. This suggests December is likely to mark the end of the easing cycle with the policy rate at 7.0%, absent a serious deterioration of growth data, or persistent weakness in inflation.  This is now our base case.

Reform failure a risk

The central bank again flagged failure of reform efforts as a negative risk that would lead to higher inflation, which may serve to stiffen the spines of a few politicians as reforms again struggle.

Political noise is likely to build as markets look ahead to the 2018 elections, which could contribute to currency weakness. Globally, tailwinds helping to lower inflation for emerging markets are largely spent.

We think there is perhaps a 20% chance of one last cut in early 2018, based on falling inflation expectations and comments from the monetary policy committee that the neutral level rates may be lower than previously estimated.