BRASILIA (Reuters) - Brazil's central bank cut interest rates to a more than three-year low on Wednesday but said it was ready to dial down the pace of easing during a political crisis that threatens government efforts to plug a widening fiscal gap.
In a widely-expected move, the bank's COPOM monetary policy committee cut its benchmark Selic rate BRCBMP=ECI by 100 basis points for the second straight time to 10.25 percent. It was the Selic's lowest level since January 2014.
Corruption allegations against President Michel Temer, which threaten to unseat the center-right politician and derail his economic reform agenda, have tempered investors' bets for a more aggressive monetary easing cycle as inflation drops sharply.
The central bank said uncertainty generated by the crisis was the main risk facing the economy as it started to show signs of recovery following two years of recession.
"The Copom judges that a moderate reduction of the pace of monetary easing relative to the pace adopted today is likely to be appropriate at its next meeting," the bank said in its decision statement.
It added that doubts about the approval of key reforms, such as a pension system overhaul, were hampering a more timely fall in the structural rate, the rate level neutral to inflation.
The bank's more cautious approach could mean a gradual easing cycle that leaves the Selic above the 8.5 percent rate the market was expecting by year end, analysts said.[nL1N1IX279]
"It was a hawkish rate cut. The bank is not comfortable with the current easing pace for the next meeting and it signaled that the ending point, which the market sees at 8.5 percent, is beginning to look a bit stretched," said Marco Caruso, economist with Banco Pine in Sao Paulo.
Temer, who rose to power after the 2016 impeachment of his running-mate Dilma Rousseff, has resisted pressure to resign amid accusations he took bribes from the billionaire owners of the world's largest meatpacker JBS SA (JBSS3.SA). Temer has denied he took bribes.
The scandal has put at risk Temer's proposal to reduce pension expenditures, which the central bank highlighted as crucial to keep inflation at bay and allow it to keep cutting rates aggressively.
A delay or further watering down of Temer's pension reform could hit business and consumer confidence and hamper efforts to close a fiscal deficit that soared past 10 percent of GDP last year.
Central bank chief Ilan Goldfajn has been under pressure from politicians and businessmen to step up monetary easing to bolster a recovery after two years of recession.
Brazil's gross domestic product BRGDP=ECI probably expanded by 1.0 percent in the first quarter from the last three months of 2016, according to the median forecast of 20 economists surveyed by Reuters. Official data is due out on Thursday at 9 a.m. (1200 GMT).
A sharp drop in inflation, which fell well below the 4.5 percent official target in mid-March, has allowed the central bank to cut the Selic by 400 basis points since October.
Reporting by Alonso Soto; Editing by James Dalgleish and Andrew Hay