Central Bank reaffirms that there is no room for interest rate cuts.

(Reuters)- The Central Bank worsened its inflation outlook for 2016, given increased pressure from food prices, but improved its outlook for 2017, although it is not at the center of the official target, according to the Quarterly Inflation Report released this Tuesday, in which it reaffirmed that there are no conditions to reduce the basic interest rate yet.

According to the document, the Central Bank now sees the IPCA (Brazilian consumer price index) rising 6,9 percent in 2016, above the previous estimate of 6,6 percent, but that the increase will lose momentum and close 2017 at 4,7 percent, 0,2 percentage points less than the previous projection. The Central Bank also projected the IPCA at 4,2 percent in the second quarter of 2018, all based on the baseline scenario.

The scenarios presented by the Central Bank were generally considered harsher, leading some experts and the financial market to foresee a later start to interest rate easing.

The document, the first under the management of the current president of the Central Bank, Ilan Goldfajn, highlighted the commitment of the Monetary Policy Committee (Copom) to keeping inflation at the center of the target in 2017 -- 4,5 percent, with a margin of 1,5 percentage points -- and that it will seek to keep it within the tolerance margin this year, of two points. Until then, Ilan had not mentioned any deadlines.

The baseline scenario considers the dollar remaining at 3,45 reais and the current Selic rate of 14,25 percent per year throughout the forecast horizon.

The market was anxiously awaiting the report, seeking more concrete clues about the monetary policy orchestrated by Ilan, especially regarding the start of the Selic rate easing cycle, which has remained unchanged since July of last year.

In their latest communications, both former Central Bank president Alexandre Tombini and directors of the institution emphasized that there is no room for easing monetary policy, a phrase also present in the current report.

"The Committee will seek to keep inflation within the limits established by the National Monetary Council (CMN) in 2016 and will adopt the necessary measures to ensure the convergence of inflation to the 4,5 percent target in 2017," the document stated. "Therefore, the central scenario does not allow for the hypothesis of easing monetary conditions," it added.

Despite acknowledging progress in combating inflation, the Central Bank stressed in its report that "its continuation depends on adjustments—primarily fiscal—in the Brazilian economy." It also drew attention to the climate problems that have affected global food production, especially grains, and the effects on domestic prices.

According to the Central Bank, the inertia in the process of realigning relative prices and uncertainties about the global economy have also affected the fight against inflation.

With the signals given by the Central Bank, shorter-term interest rates were up sharply this morning, with the curve showing a majority probability that the Selic rate reduction cycle should begin in October, practically burying the likelihood of it occurring in August. [nL1N19K0GS]

"Based on projections, the Central Bank shows that it doesn't have room to cut interest rates. With that, I think it has significantly reduced that room for this year," said Newton Rosa, chief economist at SulAmérica Investimentos, who preliminarily adjusted his projection for the start of rate cuts to October, and no longer in August. He also now sees a reduction of 1 percentage point by the end of the year, compared to 1,25 points previously.

Expectations for price increases this year have worsened in recent weeks, moving further away from the government's target ceiling. The most recent Focus survey showed that, according to the median outlook, inflation will close 2016 at 7,29 percent, falling to 5,50 percent in 2017. [nEMNG6O0RY]

EXTERIOR SCENE

The Central Bank noted that the United Kingdom's decision to leave the European Union (EU), coupled with factors such as the US elections, "increased uncertainties regarding the global economic and financial landscape, impacting volatility in financial markets."

With the dynamics of the global economic recovery still fragile, the Central Bank pointed to "the deepening of the accommodative nature of monetary policies" in important economies, with the prospect of maintaining negative interest rates.

"Given a more favorable exchange rate scenario and the prospect of negative interest rates abroad continuing for a long time, I think there's a sign that it's possible to start reducing interest rates (in Brazil) in August," said the chief economist of Banco Fator, José Francisco de Lima, but stressing that it's still "a little early to say for sure."

The Central Bank slightly improved its projection for Brazil's Gross Domestic Product (GDP) this year, now forecasting a contraction of 3,3 percent, compared to 3,5 percent previously.