May 16, 2018 / 9:49 PM / a year ago

UPDATE 2-Brazil holds rates unexpectedly amid currency selloff

(Adds details of central bank statement, analyst comment)

By Bruno Federowski

BRASILIA, May 16 (Reuters) - Brazil’s central bank unexpectedly kept interest rates unchanged on Wednesday, contradicting widespread forecasts of a cut after a selloff in emerging markets drove the Brazilian real to a two-year low.

The bank’s nine-member monetary policy committee, known as Copom, kept the benchmark Selic rate at 6.50 percent, after cutting the rate by 775 basis points since October 2016. Only two of 42 economists polled by Reuters had forecast the bank would stand pat.

The surprise move makes Brazil’s central bank the latest in emerging markets to turn hawkish as expectations of rising U.S. bond yields draw investors away from higher-yielding assets in the developing world.

Argentina’s central bank has sold reserves and hiked interest rates to 40 percent to shore up the peso, which has weakened about 15 percent this month.

The Brazilian central bank’s move marks an end to its deepest rate-cutting cycle in a decade, which dropped the benchmark rate from a nine-year high of 14.25 percent.

Policymakers have struggled to speed up a recovery in Latin America’s biggest economy after the worst downturn in decades, and inflation remains well below the official target range.

In a statement, the Copom attributed the decision to “the recent change in the balance of risks to prospective inflation.”

“The main point was the currency shock and I have no doubt that they preferred not to take a risk,” said José Francisco Gonçalves, chief economist at Banco Fator. “I still expect the Selic to begin rising only in 2019.”

A weaker currency could boost import prices and rekindle inflation, but analysts say Brazil’s weak first-quarter activity data point to a sluggish recovery that will limit passthrough of foreign inflationary pressures.

The central bank said in its decision that holding rates “is consistent with convergence of inflation to target over the relevant horizon for the conduct of monetary policy, which includes 2018 and, to a greater extent, 2019.”

The central bank targets a 4.5 percent annual inflation rate at the end of 2018 and 4.25 percent rate at the end of 2019, with a margin of 1.5 percentage points above or below. Inflation is hovering around 2.8 percent in the last 12 months.

Bank of America Merrill Lynch’s David Beker, one of the two economists who had predicted the decision, said the central bank did what “needed to be done.”

He said rates are likely to stay put until early next year, but acknowledged that could change depending on an October presidential election, one of the most unpredictable in decades.

“In terms of when they will hike, it depends both on the foreign scenario as well as the elections, but I’d say the main discussion is whether the next administration will implement an agenda of reforms,” Beker said. (Reporting by Bruno Federowski; writing by Brad Haynes; editing by Cynthia Osterman and Grant McCool)

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