Shift in external scenario broadens debate within the Finance Ministry regarding the chances of interest rate cuts in Brazil.

BRASILIA (Reuters) - Recent events that have brought turbulence to the international financial sector have fueled debate within the Ministry of Finance regarding the chances of the Central Bank cutting Brazil's benchmark interest rate sooner than previously expected. Some members of the economic team believe an earlier monetary easing is possible, while others view the events as preliminary or without any immediate effect on the Selic rate.

Amid the uncertainties generated by the collapse of the US banks SVB Financial Group and Signature Bank, aggravated by the problems at the European Credit Suisse, three sources following the issue in different areas of the ministry presented Reuters with different views on the effects of the new external scenario.

One of the officials, who requested anonymity because the discussions are not public, stated that the combination of recent external factors is yet another argument for the Central Bank to bring forward cuts to the Selic rate.

"Just look at how future interest rates are falling in response to everything that's happening," he said, citing the possibility of an increased risk of a global crisis and an inversion of the yield curve, which is seen as a harbinger of recession.

Following the disclosure of the crisis at SVB at the end of last week, there was a decrease in local future interest rates. The rate for DI (Interbank Deposit) contracts for January 2024 was at 13,16% last Friday and fell to 12,96% this Wednesday, amid expectations that the Central Bank may be forced to reduce the Selic rate more quickly than expected.

A second source, however, said it believes that future interest rates are falling due to reduced rates abroad, based on parity, not because of an anticipation by the financial market regarding the Central Bank's moves in light of this new scenario.

According to this source, the monetary authority made it clear that if a credit crisis were to hit Brazil, the instrument to combat it would be the release of liquidity lines to banks, not a cut in the Selic rate, which would be fundamentally focused on combating inflation.

“Regardless, I think the market and the Central Bank are not capturing the potential effects of lower growth and commodity prices on inflation in 2023 and 2024,” he stated, highlighting that the Central Bank's actions could change when this perception begins to emerge.

According to this member of the economic team, progress related to the fiscal framework and tax reform could also contribute to the decision to cut interest rates, "but this takes time."

A third source stated that government members are eager to see interest rates reduced, but, according to her, saying that the incidents with banks abroad are an argument for lowering interest rates in Brazil "is pushing it and is premature."

According to her, the US government has capital and strong regulatory power, which should allow it to control the crisis in the sector without a major impact on Brazil.

"I think what can reduce interest rates is tax reform and a fiscal framework. We could have a more positive Copom (Monetary Policy Committee) that already signals a willingness to do this," he said.

On Thursday, the European Central Bank (ECB) raised interest rates by 50 basis points, as promised, ignoring the chaos in the financial market generated by the banking crisis and calls from investors to ease the tightening of monetary policy at least until confidence stabilizes.

The Federal Reserve, the US central bank, meets next week to deliberate on interest rates, and investors are also divided on the possible decision, with part of the market betting on a pause in monetary tightening.

NEXT COPOM

According to reports from the Finance Ministry, there is no expectation that an interest rate cut will occur at the next meeting of the Monetary Policy Committee (Copom) next week, but the ministry will observe the signals in the Central Bank's statement regarding what may be done at subsequent meetings of the committee.

After an intense cycle of monetary tightening to curb inflation, the Central Bank has kept the Selic rate at 13,75% per year since August of last year, the highest level since the beginning of 2017.

President Luiz Inácio Lula da Silva has made a series of criticisms of the Central Bank's actions, the high level of the basic interest rate, and the low level of inflation targets.

In February, before these new episodes related to the banking sector, the president of the Central Bank, Roberto Campos Neto, stated that the country could return "soon" to the scenario in which the institution predicted it would be possible to cut the Selic rate from mid-2023 and achieve the inflation targets. According to him, this would be feasible when the government's plan for the fiscal framework and structural reforms became clearer.

According to economist André Perfeito, the Central Bank will maintain the Selic rate at 13,75% at next week's meeting, but is expected to signal future cuts. He believes the situation of banks abroad is among the reasons that could contribute to this decision.

"Even with the collapse of SVB and the problems with Credit Suisse, if the Central Bank doesn't signal that it will cut interest rates soon, you don't need to be a great political strategist to know that the Presidential Palace and the Workers' Party will unleash all their artillery on the Central Bank," he stated in a report.