May 22, 2018 / 11:43 AM / a year ago

UPDATE 2-Brazil central bank weighed rate cut before opting to hold

(Adds market reaction, details from minutes)

By Bruno Federowski and Marcela Ayres

BRASILIA, May 22 (Reuters) - Brazil’s central bank considered cutting interest rates last week but ultimately left them untouched because of potential inflationary pressure stemming from a weak currency, the minutes of its most recent policy meeting showed on Tuesday.

Last Wednesday, the bank unexpectedly kept the benchmark Selic rate at an all-time low of 6.50 percent, ending the deepest monetary easing cycle in a decade and defying widespread expectations of a 25-basis-point cut.

Yields on Brazilian interest rate futures fell in early trading as investors maintained bets that interest rates will stay low for a long time. Brazil’s currency, the real , strengthened in line with global emerging markets.

The bank acknowledged that the decision came as a surprise to part of the market, giving policymakers reason to hesitate.

“Ultimately, an understanding prevailed that focusing on the best possible decision given the set of information available at the moment results, over time, in increased credibility for monetary policy,” the minutes said.

Inflation has remained below Brazil’s official target range as a result of double-digit unemployment rates, widespread idle capacity and a slower-than-expected economic recovery, while year-end forecasts for 2018 and 2019 remain below the target’s midpoint.

Yet the recent strength of the U.S. dollar, which drove the real to a two-year low, “reduced the likelihood that inflation will remain below the target in the foreseeable future through potential second-order effects on inflation,” the minutes said.

Bets that a wider U.S. fiscal deficit and higher inflation could drive the Federal Reserve to increase rates by more than previously expected have pushed up U.S. bond yields, damping demand for emerging-market assets.

Brazil’s central bank has stepped up intervention in the foreign exchange market to cushion the real’s decline. The bank’s minutes said currency moves will drive monetary policy only insofar as they affect the outlook for inflation.

A weaker currency pushes up the cost of imports, although weak economic activity is likely to limit any pass-through to wider inflation. The central bank said it will monitor several measures of foreign exchange effects on headline inflation and underlying price trends. (Reporting by Bruno Federowski and Marcela Ayres; Editing by Bernadette Baum and Steve Orlofsky)

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