(Recasts headline, first paragraph, adds paragraph on interest rate futures)
By Bruno Federowski and Marcela Ayres
BRASILIA, Sept 19 (Reuters) - Brazil’s central bank on Wednesday held interest rates at an all-time low but said it could gradually raise them if the outlook worsens, highlighting how the upcoming presidential vote is increasingly weighing on monetary policy.
Concern about the elections has already helped depress the Brazilian real to near record lows and could soon trigger the first interest rate rise in three years depending on the result.
The bank’s nine-member monetary policy committee, known as Copom, kept the benchmark Selic rate at 6.50 percent for a fourth straight meeting, the last before October’s vote. All but one of 40 economists polled by Reuters had expected the bank to stand pat.
“Stimulus will begin to be removed gradually if the outlook for inflation at the relevant horizon for the conduct of monetary policy and/or its balance of risks worsen,” the bank said in its policy statement.
That is a major, if somewhat expected, change in the bank’s recent communication after it withheld any hints on future rate moves for months because of heightened political uncertainty.
Concerns that the winner of the elections could fail to cut government spending and plug the ballooning government deficit have magnified the effect of an emerging markets selloff on the Brazilian real, threatening to lift import prices and inflation.
“A substantial currency depreciation past current levels could drive the central bank to raise rates, if it’s not seen as temporary,” Santander Brasil chief economist Mauricio Molan said. “That is, if the market becomes skeptical over Brazil’s fiscal outlook.”
Official inflation has been hovering at around 4.3 percent, below the 4.5 percent midpoint of this year’s target range but above the 4.25 percent 2019 midpoint. Double-digit unemployment and widespread idle capacity, however, have kept underlying inflation subdued.
The central bank’s statement pointed to upward and downward risks for inflation. While an underwhelming economic recovery could weigh on prices, disappointment over structural reforms could pressure the currency and accelerate inflation, particularly if the outlook for emerging markets deteriorates further.
“The latter risks have increased,” the bank said.
Most economists in the Reuters poll expected the central bank to wait until sometime in the first half of 2019 before hiking. Still, such a move would hinge on whether the incoming president swiftly implements unpopular structural reforms, such as an overhaul of the nation’s costly pension system.
Interest rate futures, however, already priced a hike in the Copom’s next meeeting late in October.
The far-right presidential candidate Jair Bolsonaro, who has tapped a University of Chicago-trained banker as his main economic adviser, is leading in voter intention polls but it is not clear that he would beat his main leftist rivals in a likely second-round vote.
The bank on Wednesday repeated that monetary policy will only react to currency moves if they affect other prices or expectations. Should interest rates and the exchange rate remain constant, inflation would end 2018 at 4.4 percent and 2019 at 4.5 percent, the bank estimated, surpassing the midpoint of its target range next year.
If the currency strengthens and rates rise in the next two years as predicted in a weekly central bank survey of economists, however, inflation would reach 4.1 percent in 2018 and 4.0 percent in 2019, suggesting the outlook remains under control, at least for now. (Reporting by Bruno Federowski and Marcela Ayres; additional reporting by Mateus Maia; writing by Bruno Federowski; editing by Christian Plumb)