Brazil central bank says tightening effects yet to be felt, signals pause in rate hikes

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Central bank open to resuming hikes if inflation remains above 3% target

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Brazil's economy has continued to outperform expectations

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Short-term inflation outlook remains adverse

(Adds context in paragraphs 4-5, comments from economists in paragraphs 6 and 14, further central bank comments in paragraphs 12-13)

By Marcela Ayres

BRASILIA, June 24 (Reuters) -

Brazil's central bank said on Tuesday that much of the impact from its "particularly quick and very firm" tightening cycle is yet to be felt, which is why it now foresees a pause in interest rate increases to assess those effects. In the minutes of last week's decision, when the monetary policy committee Copom raised rates by 25 basis points to 15% and signaled a "very prolonged" pause ahead, the central bank also stressed that it will still assess whether the current rate is appropriate to bring inflation back to target.

Reiterating that it will not hesitate to resume hikes if needed, the central bank sought to stress that the pause does not necessarily mark the end of the tightening cycle, a message likely aimed at discouraging premature bets on when it might start easing borrowing costs.

Since September, Brazil's benchmark Selic interest rate has climbed by 450 basis points.

But despite the aggressive tightening, Latin America's largest economy has continued to outperform expectations, supported by resilient economic activity and a tight labor market, with

annual inflation

running well above the 3% target.

"How do you stop raising interest rates in a scenario like this? By trusting the lags of monetary policy. ... So now it's time to wait for it to take effect," said Luis Otavio Leal, partner and chief economist at G5 Partners, who expects an initial rate cut early next year.

Policymakers said in the minutes that the most recent data indicate that the economy continues to lose steam, albeit rather gradually.

The central bank noted that indicators for trade, services and industry point to more moderate growth, while confidence indicators remain subdued despite some recent improvement.

Given the usual lags in monetary policy transmission, these effects are expected to intensify in the coming quarters.

"The committee foresees an interruption of the rate hiking cycle to examine its yet-to-be-seen cumulative impacts, and then evaluate whether the current interest rate level, assuming it (is) stable for a very prolonged period, will be enough to ensure the convergence of inflation to the target," the policymakers wrote.

They stressed that the short-term inflation outlook remains adverse, although recent readings have surprised to the downside compared with analysts' expectations.

The central bank also voiced broad discomfort with

inflation expectations

, which remain above the official target across all horizons, even after some recent decline in shorter-term projections.

"Once the appropriate interest rate is determined, it should remain at a significantly contractionary level for a very prolonged period due to deanchored expectations," it emphasized.

Caio Megale, chief economist at XP, said the bar is likely high for increasing rates, with the minutes focused on preventing market participants from expecting rate cuts.

(Reporting by Marcela Ayres; Editing by Gabriel Araujo and Mark Porter)