In the midst of the economic crisis resulting from the pandemic of the new coronavirus, the Central Bank (BC) reduced the basic interest rates of the economy for the seventh consecutive time. The Monetary Policy Committee (Copom) unanimously reduced the Selic rate to 3% per year, with a 0.75 percentage point cut.

The decision surprised financial analysts. According to the BC's Focus survey, most economic agents expected a reduction in basic interest rates to 3.25% per year at this meeting and an additional cut to 2.75% in June.

In a statement, the Central Bank said that the committee is considering promoting a further cut, up to 0.75 percentage points, at the next meeting in June. From then on, basic interest rates would no longer be changed, but the monetary authority admitted that the risks are high and that it expects more information to define the next steps.

According to the note, two BC directors suggested more aggressive cuts, but uncertainty about the impacts of the covid-19 pandemic on the economy made most members of the Copom choose to cut interest rates in stages, until the economic picture stabilize.

With yesterday's decision (6), the Selic is at the lowest level since the beginning of the Central Bank's historical series, in 1986. From October 2012 to April 2013, the rate was maintained at 7.25% per year and to be gradually adjusted until reaching 14.25% per year in July 2015. In October 2016, the Copom reduced the basic interest rates of the economy again until the rate reached 6.5% per year in March 2018, only being reduced again in July 2019.

Inflation 

The Selic is the main instrument of the Central Bank to keep official inflation under control, as measured by the Broad National Consumer Price Index (IPCA). In the 12 months ended in March, the indicator closed at 3.3%, the lowest result accumulated in 12 months since October of last year.

Inflation, which had risen at the end of last year because of higher meat and the dollar, is now expected to fall more than expected because of the interruptions in production and consumption caused by the covid-19.

For 2020, the National Monetary Council (CMN) established an inflation target of 4%, with a tolerance margin of 1.5 percentage points. The IPCA, therefore, cannot exceed 5.5% this year or fall below 2.5%. The target for 2021 was set at 3.75%, also with a tolerance interval of 1.5 percentage points.

In the Inflation Report released at the end of March by the Central Bank, the monetary authority estimated that the IPCA would close the year at 2.6%. The projection, however, was out of date due to the covid-19 pandemic. According to the Focus bulletin, a weekly survey of financial institutions released by the Central Bank, official inflation is expected to close the year at 1.97%, but estimates are expected to continue to fall in the next surveys.

Cheaper credit 

The reduction in the Selic rate stimulates the economy because lower interest rates make credit cheaper and encourage production and consumption in a scenario of low economic activity. In the last Inflation Report, the BC projected zero growth for the economy this year. However, the prediction had been made before the coronavirus crisis worsened.

The market already projects lower growth. According to the latest issue of the Focus bulletin, economic analysts forecast a contraction of 3.76% of the Gross Domestic Product (GDP, sum of goods and services produced by the country) in 2020.

The basic interest rate is used in the negotiation of public securities in the Special System of Settlement and Custody (Selic) and serves as a reference for other interest rates in the economy. By readjusting it upwards, the Central Bank insures the excess demand that presses prices, because higher interest rates make credit more expensive and stimulate savings. By reducing basic interest rates, the Copom makes credit cheaper and encourages production and consumption, but weakens inflation control. To cut the Selic, the monetary authority needs to be sure that prices are under control and are not at risk of rising.