Deteriorating Economy Leads Brazil to Cut Interest Rates by 1%

In a surprise move, Brazil's Central Bank (BC) decided today to cut by a full percentage point its key interest rate, the Selic. The reduction from 13.75% to 12.75% is the largest one in five years and wasn't anticipated by market analysts.

Apparently, the members of Copom (Monetary Policy Committee) opted for the aggressive measure, in Brazilian terms, after pondering that the Brazilian inflation is in check and weighing the impact of the international financial crisis on the Brazilian economy.

The decision wasn't unanimous. Three directors of BC voted for a smaller cut of 0,75 percentage point, which would leave interests rate at 13% a year.

On Monday, a survey from the Central Bank showed that most Brazilian financial analysts were expecting a 0.5% cut.  However, the announcement that 654,000 jobs had been lost in December, the worst number in 10 years, seem to have changed some minds among experts and inside the BC. 

At the end of the meeting, the Copom released the following note: "Evaluating the outlook for inflation, the Copom decided, at this time, to reduce the Selic rate to 12.75% a year, without bias, for five votes in favor and three votes for the Selic rate reduction of 0.75 percentage point.

"With that, the Committee begins the process of monetary policy flexibilization carrying out immediately an important part of the interests basic rate action, without losing sight of the inflation target."

Commenting on the cut, ratings company Fitch, which currently rates Brazil at BBB- with a Stable Outlook, released a note warning Brazil to be careful not to stoke inflation:

"Falling inflation and inflationary expectations as well as a sharper-than-expected deceleration in economic activity have provided BCB the flexibility to begin an early easing cycle with an aggressive cut. However, the central bank needs to be vigilant against inflation risks stemming from a weaker Brazilian real," said Shelly Shetty, Senior Director in Fitch's Latin American Sovereign Group. 

"The BCB's interest rate cut as well as its pro-active stance to ensure adequate liquidity in the financial system should provide some support to the faltering domestic demand outlook," Shetty added.

"Maintaining a credible monetary and exchange rate policy framework will be critical for Brazil to weather the unfavorable external environment and minimize the fallout from global recession, falling commodity prices and global de-leveraging," according to Shetty.