Central Bank President defends coordinating fiscal and monetary policies to reduce interest rates.

BRASILIA (Reuters) - The Central Bank has warned that coordination between fiscal and monetary policies is important and that this is the best way to create a future environment for interest rate cuts, said the head of the institution, Roberto Campos Neto, on Thursday.

During the presentation of the inflation report, Campos Neto stated that he had a positive conversation with the future Finance Minister Fernando Haddad, affirming that the former mayor had agreed with "almost all points" of the dialogue.

He added that he had told Haddad that, depending on the form of communication, the government could spend more while generating a smaller effect on the yield curve.

"When you have more transparency, you can make the same expenditure with less damage to your credibility," he said.

According to Campos Neto, given the uncertainties surrounding the final text of the Transition Amendment, the agency has been using market expectations for the government's additional spending on the amendment, estimated at 130 billion reais, as a premise for analysis.

After the Central Bank emphasized fiscal issues as a factor of high uncertainty in its statements, Campos Neto said that the approval of the PEC (Proposed Constitutional Amendment) will be taken into account so that the Central Bank can reassess its balance of risks.

He stated that it is important to observe the effect of the measure on the trajectory of public debt, noting that it is necessary to await the approval of the text to analyze its impacts.

The president of the Central Bank indicated that he did not find the argument used by the elected government—that public spending in 2023 must remain at the same level as this year as a proportion of GDP—adequate. "This metric always has a problem with cyclicality; at some points GDP falls and the government needs to spend more. If you tie spending to a constant level relative to GDP, what happens when GDP falls and you have that situation where you need to implement a countercyclical policy?" he stated.

In the interview, the president of the Central Bank was not specific about the Central Bank's plan for a possible start to interest rate reductions, but stressed that the market reacted to the fiscal debate not only by postponing this expectation of a cut but also by introducing increases in the rate along the yield curve.

"We remain vigilant," he stated.

Regarding economic activity, the Central Bank said it expects a slowdown in growth going forward, also predicting an increase in economic slack in the country due to the effects of monetary tightening.

Campos Neto emphasized that the Central Bank issues warnings about the impacts of parafiscal measures, highlighting that the decrease in subsidized credit in recent years has been highly relevant in lowering the country's neutral interest rate and has an effect on the effectiveness of monetary policy.

According to him, a change in this policy could reverse these factors. "When effects begin to be incorporated into expectations, the Central Bank has to act," he said.

The statement was made amid speculation about the possible use of public banks by the elected government to stimulate the economy through subsidized credit. The transition team also mentioned a possible review of the Long-Term Rate (TLP), used in BNDES financing.

Campos Neto stated that the Central Bank actively participated in the formulation of the TLP (Long-Term Interest Rate), which came into effect before his term, and emphasized that the model with less subsidy from the Union represented an institutional gain and reduced the country's neutral interest rate.

Regarding his tenure, the president of the Central Bank said he intends to stay until the end of his term in 2024, a period he considers sufficient to fulfill his objectives. He positioned himself against reappointment for another term as president and said he did not discuss this issue with Haddad.

Campos Neto also highlighted that he told Haddad that the ideal approach is to conduct the process of appointing new directors to the Central Bank "in a smooth and consensual manner."

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