Can Brazil Keep It Real?

With policy rates currently at 10.5%, down from 13.75% last year, the Central Bank of Brazil (BCB) faces a host of monetary policy challenges, including an ambitious inflation target of 3% (that may be shifting), expansionary fiscal policy, global interest rate volatility, and uncertainty surrounding a BCB leadership transition as President Lula will appoint a new president by year end. Lula’s appointment could, potentially, be a more dovish central bank governor as the President’s concerns seem to be more focused on boosting growth rather than controlling inflation.

However, the central bank has, so far, been acting with independence from the executive power, keeping rates up to anchor inflation expectations that are under pressure by President Lula’s fiscal expansionary policies. While political interference concerns may undermine the BCB’s credibility, a recent unanimous decision to hold policy rates steady, despite messaging that a hike is available as necessary to battle inflation, suggests the BCB’s commitment to maintaining independence and a tight policy stance.

Furthermore, regarding the recent depreciation of the real, Roberto Campos Neto, the current central bank president, reiterated that policymakers would not intervene in foreign exchange markets despite healthy reserves unless there was dysfunction. This also helped to reaffirm the notion of an independent central bank—and one that was paying attention.

Recent weeks have seen more constructive signals from the administration, including mandatory spending cuts (R$26 billion on 4 July) and freezes (R$15 billion on 18 July) to meet fiscal targets, as well as public support for Finance Minister Fernando Haddad. Brazil’s external position also remains strong, with the trade surplus reaching new highs on oil exports. Additionally, exporters have increasingly held revenues abroad, boosting the country’s external asset balance.

Looking ahead, if higher inflation expectations keep monetary policy restrictive and uncertainty undermines investments, Lula’s popularity could suffer, likely turning him more aggressive against the central bank in demand for lower rates that can help growth recover. Additionally, the political landscape may shift if Lula’s Workers’ Party performs poorly in local elections. At the same time, the Brazilian economy is maintaining its steady outlook, boosted by a tight labor market and a solid foundation. According to Brazil’s central bank market survey and Bloomberg consensus, growth in 2024 is expected to be 2.2%.