Brazil's central bank signals prolonged high rates as tightening impact builds

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Policymakers express confidence in slowing economic activity

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They see cooling signs in credit market, business sentiment, currency rate, balance sheets

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Many economists expect aggressive tightening cycle has ended

By Marcela Ayres

BRASILIA, May 13 (Reuters) - Brazil's central bank said on Tuesday it sees clear signs that its aggressive monetary tightening cycle is working, with the impact to broaden in the coming quarters, a scenario that calls for an extended period of high borrowing costs. In the minutes of last week's policy meeting, when the central bank raised its benchmark interest rate by 50 basis points to 14.75% and refrained from providing forward guidance, policymakers said some factors made them confident that growth would moderate after years of unexpectedly strong economic activity. "The restrictive monetary policy has already had effects on the credit market, business surveys, the exchange-rate market, corporate balance sheets, as well as in the moderation of certain activity and labor market indicators," they wrote.

"In view of the lags inherent to the monetary policy mechanisms, these effects are expected to deepen in the coming quarters," they added. Against this backdrop, the central bank reiterated that "the scenario prescribes a significantly contractionary monetary policy for a prolonged period to ensure inflation converges to the target."

Caio Megale, chief economist at XP, said the central bank appears to be charting a course to keep interest rates steady in the coming meetings, albeit without a firm commitment.

Megale, however, expects the central bank to hike rates by 25 basis points next month due to domestic inflationary pressures, including those stemming from government stimulus measures.

Alberto Ramos of Goldman Sachs said the minutes point to "an inflection point on growth," but with inflation dynamics still challenging, making it a close call whether the central bank will deliver a final 25 basis-point hike in June. After the central bank last week dropped language about the need for a "more contractionary" stance and stopped describing the balance of inflation risks as tilted to the upside, many economists had concluded the rate-hiking cycle - which has so far lifted borrowing costs by 425 basis points - was over. According to a weekly central bank survey, economists now expect rates to remain steady in June.

The minutes showed policymakers had discussed whether the balance of risks to inflation remained slightly asymmetric, albeit less so than in the previous meeting, or whether it could already be considered neutral. Policymakers also said new government rules for payroll-deductible loans should not be seen as a cyclical measure and may represent a structural change in the credit market, factoring in only a mild impact on their aggregate projections due to the program.

Bradesco's economics team said the minutes are consistent with its current view that the tightening cycle is over, but noted that a fading global shock following the

U.S.-China trade truce

and stronger economic activity data could prompt policymakers to reassess the outlook. (Reporting by Marcela Ayres; Editing by Oliver Griffin, Kirsten Donovan and Paul Simao)