(Bloomberg) — Brazil’s central bank is at risk of having to raise interest rates more than expected just a month after surprising investors with a bold rate hike, according to former central bank chief Gustavo Loyola.
The second wave of the Covid-19 pandemic and a complicated discussion about this year’s budget made monetary policy difficult, said Loyola, who presided over the monetary authority twice during the 1990s. Faced with the country’s “anemic” activity and inflationary pressures from rising energy and food costs, policy makers have opted to merely monitor both — a strategy that could force the bank to raise rates more than it already signaled.
“They’re in a difficult position,” Loyola, currently a managing partner at Tendencias Consultoria, said in an interview. “They’re waiting to see what the scenario will bring, if this pace of tightening is enough to anchor inflation expectations.”
The central bank raised the benchmark Selic rate by 75 basis points to 2.75% last month, and indicated another increase of the same size in May. The move — the first this year among the Group of 20 nations — surprised economists, who had expected a 50 basis point hike, but now traders are already pricing in an even stronger tightening, according to Loyola.
The former policy maker said that central bank chief Roberto Campos Neto “did everything right” when the coronavirus pandemic broke out in the country, but was caught off guard by the resurgence of the pandemic this year. The new wave of the virus, worse than the first in both infection and death counts, demanded more spending and hindered economic recovery forecasts.
The recent agreement over this year’s budget left several lose ends that will continue to spark uncertainty about the country’s fiscal accounts, further complicating the central bank’s job, he said.
Doubts over the trajectory of public accounts combined with political noise and a “poor performance” in managing the pandemic have also weighed on the real, which should be benefiting from the rise in commodity prices, according to Loyola. The real is down about 4.8% this year, the worst-performing major currency in the world.
In order for the real to appreciate, investors would have to see the government moving forward with its reform agenda and setting a clear path to reduce the public deficit in the years ahead, he said.
The possibility of a clash between left-wing Luiz Inacio Lula da Silva and President Jair Bolsonaro in the 2022 elections is also beginning to weigh on investors’ minds, according to Loyola.
“That doesn’t spell anything good for Brazil, as we know both are incapable of managing” the country, he said. “Brazil needs to reinvent itself politically to win over investors.”