(Adds Pereira comments and market reaction)
By Alonso Soto
BRASILIA, July 24 (Reuters) - Brazil's central bank must remain vigilant if it is to cut inflation in half to meet its official target next year, bank director Luiz Pereira said on Friday, signaling more rate hikes as markets fear the government is loosening its policy of fiscal austerity.
Pereira's comments came two days after President Dilma Rousseff shocked markets with a dramatic reduction of the government's fiscal savings targets for 2015, 2016 and 2017, following a continued drop in tax revenues.
Many market observers interpreted the target cuts as a signal that government will not cut expenditures as aggressively as planned, effectively an admission that the government would not be able to help the central bank in easing inflationary pressures ahead. The government helps to reduce price pressures by reducing public expenditures.
Vigilance is "paramount," Pereira said in a speech posted on the bank's website.
"Progress so far in fighting inflation needs to be balanced against more recent risks that threaten our central objective," he said. "Therefore, we should remain cautious at this particular juncture."
Pereira did not say what those recent risks were, but said monetary policy should remain "adequately calibrated" to reach its goal of 4.5 percent inflation, the midpoint of its target range of 2.5 percent to 6.5 percent by late 2016. Inflation in the country rose to 8.89 percent in June.
Short-term interest rates futures <0#2DIJ:> shot up after Pereira's comments, as traders pared bets that the central bank would slow the pace of interest rates hikes next week.
Most market traders expect the central bank to raise its benchmark Selic rate by 50 basis points for the sixth straight time since December on Wednesday to bring down inflation. (Additional reporting by Bruno Federowski; Editing by Bill Rigby)