Spending cap breach forces Brazil to raise interests higher, and quicker

When it was announced last week that the Brazilian government would poke holes in its federal spending cap to pay for a new wealth transfer scheme and reignite President Jair Bolsonaro’s feeble re-election hopes, markets went into a tailspin. Four key lieutenants of Economy Minister Paulo Guedes tendered their resignation and the São Paulo stock exchange saw losses of over 4 percent in Friday morning trading. On Monday, the Central Bank’s Focus Report survey showed worsening projections for GDP growth, inflation, and the Brazilian Real.

However, the first concrete economic repercussion of the government’s decision to ignore austerity rules will only come tomorrow, when the Central Bank’s monetary policy committee Copom meets to decide on Brazil’s new benchmark interest rate.

The so-called Selic rate has seen gradual increases since Brazil’s pandemic peak in March, but markets are expecting a hike of at least 1.25 base points on Wednesday, up from 6.25 percent to 7.5 percent. Before the Economy Ministry’s spending announcement, analysts predicted a rise of 1 base point.

This increased forecast was also revealed in Monday’s Focus Report, showing a broad scenario of uncertainty that worsened all projections for Brazil’s main economic indicators.

Between now and the end of the year, the Copom will meet one final time and is set to increase the benchmark interest rate even further. According to markets, Selic will finish 2021 at 8.75 percent...