Copom reduces the basic interest rate of the economy to 13.25% per year

This is the first time the Central Bank (BC) has lowered the Selic rate in three years.

The sharp decline in inflation led the Central Bank (BC) to cut interest rates for the first time in three years. By a 5-4 vote, the Monetary Policy Committee (Copom) reduced the Selic rate, the basic interest rate of the economy, by 0.5 percentage point to 13.25% per year. The decision surprised the financial market, which was expecting a 0.25 percentage point cut.

The President of the BC, Roberto Campos Neto, and the directors Ailton de Aquino Santos (Supervision), Carolina de Assis Barros (Administration), Gabriel Galípolo (Monetary Policy), and Otávio Damaso (Regulation) voted in favor of a 0.5 percentage point reduction. The directors Diogo Guillen (Economic Policy), Fernanda Guardado (International Affairs), Maurício Costa de Moura (Relationship, Citizenship, and Conduct Supervision), and Renato Dias Gomes (Organization of the Financial System) voted for the 0.25 percentage point cut. Campos Neto’s vote was decisive.

In a statement, Copom informed that the decline in inflation allowed the interest rate reduction. ‘The committee assesses that the improvement in the inflation outlook, partly reflecting the lagged effects of monetary policy, combined with the decline in long-term inflation expectations, following the recent decision of the National Monetary Council on the inflation target, allowed for the necessary confidence to start a gradual cycle of monetary easing,’ the statement highlighted. Copom also announced that all members of the committee foresee 0.5 percentage point cuts in the next meetings.

According to the statement, the committee believes this will be the appropriate pace to maintain the necessary contractionary monetary policy (interest rates that discourage economic activity) to control inflation. The last time the BC had reduced the Selic was in August 2020, when the rate dropped from 2.25% to 2% per year. After that, Copom raised the Selic 12 times in a row, in a cycle that began amid rising food, energy, and fuel prices, and from August last year, kept the rate at 13.75% per year for seven consecutive times.

Before the start of the tightening cycle, the Selic had been reduced to 2% per year, the lowest level in the historical series that began in 1986. Due to the economic contraction caused by the covid-19 pandemic, the Central Bank had cut the rate to stimulate production and consumption. The rate remained at the lowest level in history from August 2020 to March 2021.

Inflation

The Selic is the Central Bank’s main tool to control the official inflation, measured by the National Consumer Price Index (IPCA). In June, the indicator was negative at 0.08% and accumulated 3.16% in 12 months. In the last two months, inflation has been falling due to food and fuel prices. The index closed last year above the inflation target ceiling.

For 2023, the National Monetary Council (CMN) set an inflation target of 3.25%, with a tolerance margin of 1.5 percentage points. Therefore, the IPCA could not exceed 4.75% or fall below 1.75% this year. In the Inflation Report released at the end of June by the Central Bank, the monetary authority estimated that the IPCA would end 2023 at 5% in the base scenario. However, the projection could be revised downward in the new version of the report, which will be released at the end of September. Market forecasts are more optimistic than the official ones. According to the Focus Bulletin, a weekly survey with financial institutions released by the BC, the official inflation is expected to end the year at 4.84%. A month ago, market estimates were at 4.98%.

More expensive credit

The reduction of the Selic rate helps stimulate the economy. This is because lower interest rates reduce the cost of credit and encourage production and consumption. On the other hand, lower rates make inflation control more difficult. In the last Inflation Report, the Central Bank projected a 2% growth for the economy in 2023.

The market projects higher growth, especially after the announcement that the Gross Domestic Product (GDP, the sum of all goods and services produced) grew 1.9% in the first quarter. According to the latest edition of the Focus Bulletin, economic analysts predict a 2.24% expansion of the GDP in 2023.

The basic interest rate is used in the negotiations of government bonds in the Special System of Clearance and Custody (Selic) and serves as a reference for other interest rates in the economy. By raising it, the Central Bank curbs the excess demand that puts pressure on prices because higher interest rates increase the cost of credit and encourage savings. By reducing the basic interest rates, Copom lowers the cost of credit and encourages production and consumption, but weakens inflation control. To cut the Selic, the monetary authority must be confident that prices are under control and do not run the risk of rising.