While the vast majority of central banks around the world are cutting policy rates, Brazil stands out as an exception. The Central Bank of Brazil (BCB) recently initiated a hiking cycle. The shift in monetary policy comes amid a worsening perception of fiscal policy that has impacted asset prices and the Brazilian real (BRL). Meanwhile, inflation expectations in the BCB’s weekly Focus Survey (see Exhibit 1) remain unanchored, and stronger growth recently pushed the central bank’s output gap forecast to +0.5% from neutral.
Markets are currently pricing in around 260 basis points of hikes (see Exhibit 2) through September 2025, while other central banks around the world will continue cutting or accelerating the pace of cuts against a backdrop of falling inflation and US Federal Reserve (Fed) easing.
Where Brazil goes from here remains in question. Previously, President Luiz Inacio Lula da Silva (Lula) was known to voice strong complaints over high interest rates. Economist Gabriel Galipio, Lula’s appointee, will take the helm of the central bank in December. Two other new members will also join. In December 2025, Lula will appoint two additional members. While the concentration of Lula appointees may be cause for concern, the president recently has appeared to have acquiesced to the need higher rates. And compared to during his prior terms as president, the central bank is now independent. As it stands currently, an increase in the policy rate will take the ex-ante real rate back above 8% (see Exhibit 3), which is well above the estimated real neutral rate.
Recent broad-based stimulus measures announced by China and carry improvement from rate hiking could help support BRL (see Exhibit 4), which we see as undervalued. Given current market expectations for the Fed and the BCB, the policy rate differential between Brazil and the US should improve by 300-400bps. Furthermore, we would expect any improvement in confidence around fiscal policy to support both Brazilian bonds and BRL.
We will be closely following inflation expectations, the 2025 budget, and Lula’s reaction over the coming months as monetary policy lags begin to impact growth.
Index Definitions
The Índice Nacional de Preços ao Consumidor Amplo or the Extended National Consumer Price Index (IPCA) is the benchmark inflation index of the Central Bank of Brazil. IPCA approximates the average consumption of families with household income ranging from 1 to 40 minimum wages, living in main urban areas.
Michael Arno, CFA
Portfolio Manager & Senior Research Analyst
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