Brazil's Central Bank Cuts Benchmark Rate to Near Its Lowest Level Ever -- Update

By Paulo Trevisani and Jeffrey T. Lewis Features Dow Jones Newswires

BRASÍLIA -- Brazil's central bank Wednesday cut its benchmark interest rate to near its lowest level ever, to boost a feeble economy that has begun to recover despite political paralysis in Latin America's largest nation.

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The bank trimmed its Selic rate to 7.5% from 8.25%. A rapid slowdown in price increases has allowed the bank to cut the Selic from 14.25% over the past year. Annual inflation was 2.5% in September, well below the bank's target of 4.5%.

The bank said inflation developments remain favorable, and that the country's economic situation "prescribes accommodative monetary policy."

Wednesday's cut follows four larger ones of a full percentage point each. Central-bank communication has indicated the Selic will end this year at 7%, with analysts divided over the possibility of further cuts in 2018. The Selic reached its lowest point of 7.25% in 2012.

The Selic could already be near an accommodative level, according to Camila Abdelmalack, economist at brokerage firm CM Capital. "It isn't clear whether it can go below 7%," she said.

Lower rates are bringing relief to an economy that suffered through its worst recession on record in 2015 and 2016 and is expected to expand only 0.7% in 2017. Next year should see more robust growth of 2.5%, according to economists polled weekly by the central bank.

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"The reduction [in the Selic] from a year ago is giving consumers and businesses access to cheaper financing," said Sergio Furio, chief executive and founder of consumer lending company Creditas, adding he expects a half-point cut at the central bank's policy meeting Dec. 6.

With the higher cost of borrowing before, "companies didn't invest," he said. "Now investment should pick up."

The weak economy, along with high unemployment and an excellent year for farmers, have helped take pressure off prices over the past year, allowing the central bank to cut the Selic close to the 2012 low.

The bank started that previous rate-cutting cycle in August 2011, while consumer prices were still rising faster than the target and government spending was boosting demand. Inflation slowed to close to the target in May 2012, but then accelerated again until reaching a 12-year high of 10.7% in January 2016.

Some economists say the government is still fueling inflation by spending too much, flooding the economy with money and stifling private investment. Brazil's budget gap was equal to about 9% of gross domestic product in August, up from 1.8% of GDP in 2011.

Lower borrowing costs will help shrink the deficit in coming months, says economist Alessandra Ribeiro, from the Tendências consulting firm. She said annual interest payments were equal to 6.5% of GDP in August, down from 8.5% of GDP in 2015. They likely will keep falling as long the Selic remains relatively low, Ms. Ribeiro said.

"The easing cycle is already helping the fiscal side," she said.

Much government spending in Brazil is enshrined in the constitution and can only be cut with supermajorities in Congress, something increasingly unlikely as politicians turn their focus to the October 2018 general election.

The government has pushed for tightening retirement rules as a way to help balance the budget, but efforts to do so have been hamstrung after corruption charges were brought against President Michel Temer. Even as the rate decision was announced, Congress was debating the charges, which distracted lawmakers and sapped Mr. Temer's political support. Mr. Temer has denied wrongdoing.

Until more effective measures to control government spending are in place, Brazil's central bank needs to tread a fine line, according to Goldman Sachs Latin America economist Alberto Ramos.

"The risk now is cutting rates too much," he said, adding the bank would be wise to leave the Selic at 7% through 2018.

"Markets have assumed a certain amount of reform would be done by the incumbent administration and more will be done by the next one," Mr. Ramos said. "We shouldn't be so sure it will happen."

Write to Paulo Trevisani at paulo.trevisani@wsj.com and Jeffrey T. Lewis at jeffrey.lewis@wsj.com

(END) Dow Jones Newswires

October 25, 2017 17:35 ET (21:35 GMT)