(Bloomberg) -- Brazil’s central bank held its key interest rate in a unanimous vote, fueling a rally in the real as it signaled borrowing costs will be steady for a prolongued period to battle rising inflation estimates.

Policymakers kept the benchmark Selic unchanged at 10.5% late on Wednesday, as expected by nearly all economists in a Bloomberg survey. They paused an easing cycle that had lowered rates by 3.25 percentage points. 

The Brazilian real gained as much as 0.9% against the dollar on Thursday morning, leading global gains. Short-end swap rates fell as the decision soothed investors who had grown skeptical about the central bank’s inflation fight after May’s split decision on rates. Consumer price forecasts worsened significantly on those doubts and fears of higher public spending. 

In a statement, central bankers wrote that they decided to “interrupt” their rate cuts due to an uncertain global environment, resilient domestic economy and a rise in inflation estimates — both their own and from markets.

“Monetary policy should continue being contractionary for sufficient time at a level that consolidates both the disinflation process and the anchoring of expectations around the targets,” they wrote. Board members will stay vigilant, and “potential future changes in the interest rate will be determined by the firm commitment of reaching the inflation target,” they wrote.

The decision stands to provoke the ire of President Luiz Inacio Lula da Silva, who has stepped up his criticism of monetary policy, saying he will seek a governor who’s “immune” to financial market jitters and also focused on growth once Roberto Campos Neto’s term ends this year.

In another sign of growing political pressure over the monetary authority, the ruling Workers’ Party demanded in court that Campos Neto abstain from making political remarks and supporting any candidate seeking public office until the end of his term. The lawsuit filed late on Wednesday was prompted by the central bank chief’s decision to attended a ceremony in his honor organized by Sao Paulo Governor Tarcisio de Freitas, an heir to former President Jair Bolsonaro who’s seen as a potential challenger to Lula in 2026.

The central bank didn’t immediately reply to a request for comment on the lawsuit.

What Bloomberg Economics Says

“The unanimous interest-rate hold and post-meeting statement suggest Brazil’s central bank may leave the Selic as is for longer than analysts expect. At the same time, it doesn’t indicate policymakers are considering rate hikes, currently priced in the yield curve. We see the Selic closing the year at 10.5% and upside risks to our 9.5% forecast for the end of 2025.”

— Adriana Dupita, Brazil and Argentina economist

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In their statement, policymakers wrote that headline consumer prices have been following a path of disinflation. Still, various measures of underlying cost-of-living increases are above target.

The board raised its 2024 and 2025 inflation estimates further above the 3% target using parameters from its weekly economist survey that show rates falling next year. In an alternative scenario with a constant Selic through the policy horizon, their projections stand at 4% for 2024 and 3.1% for 2025.  

Analysts see consumer price increases above target through 2026, and, until now, traders have priced in rate hikes for later this year. Most recently, annual inflation in May accelerated to 3.93% on resilient service costs.

“They set a high bar to raise rates,” said Gustavo Pessoa, a founding partner at Legacy Capital. “The most probable scenario is for the Selic to be kept steady for a prolonged period.”

Complex Environment

Lula will nominate both a new central bank governor and two new directors later this year. Those picks will consolidate his sway over the board, a prospect that concerns investors given that he has often criticized borrowing costs and the inflation target as being too high.

The powerful influence of the leftist president is part of the reason local assets sold off following the central bank’s May rate decision, when his four current appointees dissented in favor of a larger rate cut.

Part of investors’ jitters also centers on fears the government will waiver in its pledge to bolster public accounts and keep a lid on debt. Lula said this week he is willing to make spending cuts, as long as his economic team demonstrates they are necessary.

This month, Congress killed the latest proposal to raise revenues. That reversal came after Lula’s administration said in April it will aim for a balanced primary budget — which excludes interest payments — instead of a surplus in 2025. 

In their statement, central bankers reiterated that they will closely monitor fiscal developments. They wrote that a credible fiscal policy contributes to the anchoring of inflation expectations, thus helping monetary policy.

“The environment has become more complex,” said Caio Megale, chief economist at XP Investimentos. “Our view is that rates will remain on hold at 10.5% through the end of 2025.”

--With assistance from Giovanna Bellotti Azevedo, Giovanna Serafim, Josue Leonel and Leda Alvim.

(Recasts with market reaction; adds lawsuit against Campos Neto in seventh paragraph.)

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