Gabriel Galípolo and the future of Brazil’s interest rates

The Monetary Policy Committee of the Central Bank of Brazil decided to raise the interest rate by a full percentage point in its January meeting, and again by a similar magnitude on 19 March to bring the key rate to 14.25 per cent, marking five consecutive increases. Former Governor Roberto Campos ended 2024 with a full percentage point rate hike, and this has already been doubled by Gabriel Galípolo, President Luiz Inácio Lula da Silva’s pick which Congress approved as the new Banco Central do Brasil (BCB) governor, as he began his four-year term in 2025. Galípolo’s credentials include being the previous president of Banco Fator between 2017-2021 as well as being executive secretary of the Ministry of Finance last year and, most recently, the director of monetary policy at the BCB. 

Delicate balance

The changing of the guard carries the debate on whether or not the BCB under Galípolo can withstand pressure from the Lula administration that puts economic growth as its topmost priority. 

There are concerns if the new central bank chief would be more tolerant of high inflation in exchange for lower interest rates, which would support stronger domestic economic activity. Since the BCB started policy tightening late, it now needs to pick up the pace of interest rate hikes to rein inflation closer to the 3 per cent annual inflation target – and in the process, maintain its credibility. Inflation trended above 4 per cent in the second half of 2024 and climbed to 5.06 per cent in February. Such a trend is mirrored by Brazil’s Extended National Consumer Price Index (IPCA) seen in Graph 1. 

The general sentiment is that inflation expectations have become unanchored, with the market doubting the BCB’s ability to meet even the 4.5 per cent inflation cap for 2024. Full-year inflation settled far higher at 4.83 per cent. As such, the 3 per cent inflation target for 2025 is viewed as unrealistic by market participants. 

Risk of overheating

Brazil’s economy has been gaining momentum with faster GDP growth, but a tight labour market and rising services prices are exerting pressure. Given this scenario, there is little room for monetary easing just yet. As it stands, further interest rate increases are needed to decisively cool inflation. 

Contrary to the global trend of interest rate cuts led by the US Federal Reserve, Brazil is raising rates.  The future interest rate curve, for example, projects the Selic rate to reach 15 per cent. In this context, fixed-income assets like IPCA+6% and government bonds remain attractive options for investors. Additionally, in a scenario of rising rates, post-fixed securities are also worth considering.

Additional inflationary pressure is drawn from global developments. With US President Donald Trump’s return to the White House, tighter trade policies, including higher tariffs and lower income taxes, are on the table that will strengthen the US dollar against emerging market currencies and work against commodity exporters. Trump’s return also raises the risk that the interest rate curve will come under pressure due to the US’ delicate fiscal situation, and more tariffs tend to raise the prices of Treasury bonds. 

Trump’s second term can also mean long-term interest rates in the US will remain high, making it harder for the Brazilian real to appreciate. Higher import duties in the US will negatively impact some sectors of the Brazilian economy such as agriculture, where Brazil enjoys a comparative advantage. Although the country will be affected by US protectionist measures, this presents an opportunity to ramp up bilateral trade with China. Investors can look to sectors such as agriculture and metallurgy that can benefit from warmer ties with Beijing. 

Concern about Brazil’s fiscal policy is in the spotlight once more. The government’s push to slash public spending to reduce the fiscal deficit – and with it, the debt burden – has become more challenging given worsening external conditions and a depreciating exchange rate that only makes outstanding foreign currency loans more expensive. The Brazilian government managed what seemed to be the impossible in 2024 with a primary deficit of BRL 74.6 billion (USD 8.2 billion), equivalent to 0.4 per cent of GDP. 

In the last week of November 2024, the government announced a spending cut package and a corresponding income tax reform to get Brazil’s fiscal house in order. The package was in line with market expectations, although the tax reform, which expands the exemption range for those who earn up to BRL 5,000 (USD 795) per month, was a bad surprise. However, both houses of Congress voiced support to the planned federal spending reductions, partially easing the pressure on the exchange rate. Galípolo will need to hurdle elevated inflation while navigating a tricky fiscal framework heading into 2025, and market players in Brazil will be watching closely.