Economy

The Lowest Rate and the Deepest Cut: What to Expect in Brazil and the US

Interest rate cuts often result in a reduction in the cost of credit, which also results in lower rates for consumers. But there's more than that

US and Brazil currencies.
  • The Federal Reserve has announced the deepest cut in interest rates in over a decade, to a range of 2% to 2.25% per year. On the same day, the Brazilian Central Bank has reduced its interest rates to 6 % per year.
  • Generally speaking, interest-rate cuts reduce the cost of credit, which also results in lower rates for consumers.
  • The Latin American giant needs to capture the interest of foreign investors to sustain the return to  growth on several fronts.

This Wednesday, the Federal Reserve has announced the deepest cut in interest rates in over a decade, to a range of 2% to 2.25% per year. On the same day, the Brazilian Central Bank, the monetary authority in the country, has also reduced its interest rates, a move that took the number to its lowest level in the history of the country: 6 % per year. 

In the United States, the move targeted the sustaining of economic expansion. It was the first cut in interest rates since 2008, aimed at supporting the US economy in the face of trade disputes with China.

In Brazil, the cut was also aimed at stimulating the economy, but taking a different approach, as the country emerged from its worst recession in 2018 and has recorded very low growth rates since then.

The rate reduced in the US is the federal funds rate. This is a reference for banks and other financial institutions charging one another in short-term operations. The general tax rate, called “Selic,” in Brazil has the same function.

Generally speaking, interest-rate cuts reduce the cost of credit, which also results in lower rates for consumers. But this usually only happens after a while and if other factors like default and market concentration are also under control, i.e. low. 

In Brazil, however, the five largest banks still concentrate more than 80% of credit, and default rates are still high despite macro and microeconomic measures taken by the Central Bank in the last few years.

That’s why even with the Selic rate at its lowest level in decades, bank interest rates remain at high levels in Brazil by international standards. In June, according to Central Bank data, the average bank rate (individual and corporate) amounted to 38.3% per year, while for individuals, it totaled 53.2% per year. In some cases, such as overdraft, they are over 300% per year.

According to an analysis by the executive director of the National Association of Finance, Administration and Accounting Executives (Anefac), Miguel Ribeiro, bank rates only tend to drop significantly when the economy grows again more intensely – something that should only take place from 2020 onwards, according to specialists.

Still on Wednesday, some investors interpreted Fed Director Jerome Powell’s speech as a sign that there will be no further interest rate cuts in 2019. This was not exactly expected and should affect decision-making by investors and executives. The decision toppled the New York Stock Exchange and caused the dollar to close the day above R$ 3.80, the Brazilian currency.

Normally, lower interest rates in the United States draw investors, in detriment of emerging countries like Brazil. The assessment is simple: the largest economy in the world, with low costs and high growth prospects versus a still sliding economy that suffers from high costs and legal insecurity in many sectors.

But the uncertainties generated by the Fed’s decision may not come at a bad time for Brazil. The first-round approval of the Social Security reform and the maintenance of inflation within the target were two of the factors that motivated the Selic reduction, according to the Central Bank. 

“The Copom recognizes that the process of reforms and adjustments needed in the Brazilian economy has advanced, but emphasizes that the continuity of this process is essential for the fall of the structural interest rate of the economy, ” said the Central Bank in a statement.

The Latin American giant needs to capture the interest of foreign investors to sustain the return to  growth on several fronts: from buyers to state-owned companies that are in the process of being privatized and investors interested in meeting the country’s infrastructure and technological needs.

Internally, the interest rates are important to stimulate consumption and stimulate job creation. Analysts heard by the official bulletin of Brazilian Central Bank, called “Focus”, every week, say that they expect interest rates to drop even more, to 5.5% per year in the end of 2019.