Brazil central bank signals mixing pauses with cuts to steer inflation to target

* Policymakers flag inflation risks as skewed to the upside

* Adopt longer horizon for inflation convergence to curb volatility

* Economists now see a possible pause in easing in August (Adds comments from economists in paragraphs 4-5 and 9)

By Marcela Ayres

BRASILIA, June 23 (Reuters) - Brazil's central bank on Tuesday signaled a preference for combining periods of pause and renewed easing to bring inflation back to its 3% target by the first quarter of 2028, arguing that delaying the convergence horizon helps avoid unwanted volatility.

The message came in the minutes of its latest rate decision, in which policymakers said scenarios using this strategy produced smaller output fluctuations.

They also stressed that paths to ensure inflation convergence to the target by the end of 2027, its current relevant horizon, would require "abrupt changes in direction and of large magnitude in the Selic rate, followed by several quarters of inflation below the target." Alberto Ramos, head of Latam economics at Goldman Sachs, no longer expects a rate cut at the next meeting and raised his end-of-2026 rate estimate to 14.00% from 13.25%, noting the central bank flagged, for the first time, that its inflation risk balance is skewed to the upside. "We expect the (rate-setting committee) Copom to halt the rate normalization cycle and to resume cuts at the earliest by fourth quarter of 2026," he said. Last Wednesday, the central bank cut rates by 25 basis points for a third straight meeting, to 14.25%, and again left its next steps open despite higher inflation projections. The decision steepened the yield curve after the bank argued that bringing inflation to target over the fourth quarter of next year would push it below the official goal in the subsequent quarter, which will become the reference horizon for the next policy decision in August.

Many read the communication as a stretch to justify continued easing against a more adverse inflation backdrop, reflecting not only price pressures from the Middle East conflict but also stimulus measures by the government of President Luiz Inacio Lula da Silva, who will be seeking re-election in October. Caio Megale, chief economist at XP, said the door remains open for an additional rate cut, but that the hawkish tone of the outlook and the preference for a path involving pauses suggest the central bank's current plan includes holding rates at its next meeting. The bank said in the minutes that, for now, interest rate paths closer to those in its weekly Focus survey and market pricing are more appropriate, "as they avoid inducing excessive volatility in financial asset prices and macroeconomic aggregates, with effects that could be counterproductive to the convergence of inflation to the target."

It also said best monetary policy practice recommended not fully responding to price changes driven by supply shocks, which are subject to high uncertainty.

These include not only the effects already materializing, such as those stemming from the Middle East conflict, but also risks embedded in projections that have yet to materialize, such as the potential impact of El Nino. (Reporting by Marcela Ayres; Editing by Andrew Heavens, Chizu Nomiyama and Tomasz Janowski)