Brazil as a bugbear for central bankers

While Western central banks are cutting interest rates, Brazil's central bank is taking a completely different course. This counterintuitive move is a clear signal that it is dangerous to call firefighters too soon in the fight against inflation.

In less than four years, Roberto Campos Neto’s status has gone from monetary trendsetter to national scapegoat. Neto took over Brazil’s central bank just before it officially became independent in February 2021. In the face of rising inflation, he raised the official interest rate from 2% to 2,75% a month later. He was way ahead of his time. The European Central Bank, for example, only dared to raise its policy rate much later. When the first European rate hike finally came, Brazilian interest rates had already almost reached a ceiling of 13,75%. Thanks to Neto’s bold rate hikes, Brazilian inflation subsequently fell from over 12% to just over 3% by the summer of 2023.

Way ahead of time
Because Neto acted so quickly, the Banco Central do Brazil (BCB) was also able to start cutting interest rates early. The first rate cut came about a year and a half ago. At that time, central banks in many Western countries were still working hard to get inflation under control. However, Neto will not look back on the past few years very happily. In June of this year, Brazil's inflation target was set at 3%, with a bandwidth of 1,5%. However, since the spring, inflation has slowly but surely started to rise. In November, inflation of 4,9% even climbed well above the top level of the bandwidth.

Against the flow
For Neto and the BCB, this was a signal to take a clear step up in the policy rate. The policy rate was raised by no less than 100 basis points to 12,25%. In a period in which almost all Western central banks are lowering their interest rates a bit, Brazil is once again swimming against the tide. Neto is being criticised for the interest rate hike. In particular, President Luiz Inazio Lula da Silva – nicknamed Lula – who took office at the beginning of last year, accuses him of putting an unnecessarily high brake on economic growth with a very high interest rate. This threatens to fall back from almost 3% this year to just over 2% in 2025.

Real in the corner
This accusation is particularly painful because Lula's own liberal fiscal policy is a major reason for the rising inflation. In the year since Neto launched his progressive interest rate policy, the real has risen by more than 20% against the dollar. None of that gain is left now. Partly because Brazilian interest rates fell much earlier and more sharply than in the Western world, the currency has fallen by 2024% in 19 alone. It remains to be seen whether Neto's interest rate hike will be enough to turn the tide for the real. Currency traders are at least as concerned with the political course that Lula and Trump are taking as with the measures of the trendsetting BCB.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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