By Marcela Ayres

BRASILIA (Reuters) – Brazil’s central bank commenced an interest rate-hiking cycle on Wednesday with a 25 basis-point increase, as anticipated, and indicated more raises to address a challenging inflation outlook driven by better-than-expected economic activity.

The rate-setting committee, known as Copom, voted unanimously to elevate the benchmark Selic interest rate for the first time in over two years to 10.75%, aligning with most forecasts.

While the U.S. Federal Reserve initiated its highly anticipated easing cycle earlier in the day, Brazil’s central bank began moving in the opposite direction and left the possibility open for larger increases.

“The pace of future adjustments of the interest rate and the total magnitude of the cycle that just started will be determined by the firm commitment of reaching the inflation target and will depend on the inflation dynamics,” Copom stated in its policy announcement.

Policymakers indicated that the balance of inflation risks has shifted to the upside, highlighting a stronger-than-anticipated labor market and vigorous growth.

“The situation, characterized by resilient economic activity, labor market pressures, positive output gap, increased inflation projections, and unanchored expectations, requires a tighter monetary policy,” they noted.

Gustavo Sung, chief economist at Suno Research, projected two additional rate hikes of the same magnitude in November and December, raising the benchmark rate to 11.25% by year-end.

The central bank maintained its policy rate at 10.50% in June and July after a series of cuts last year reduced it from a six-year high of 13.75%.

Expectations for a rate hike, the bank’s first since August 2022, solidified after second-quarter activity significantly outperformed projections due to a solid labor market and rising wages in Latin America’s largest economy.

However, expectations for tighter policy began to build late July when central bank minutes suggested policymakers would not hesitate to increase borrowing costs if necessary amid rising inflation risks. Since then, the bank’s communication has become more hawkish, notably from monetary policy director Gabriel Galipolo, confirmed as President Luiz Inacio Lula da Silva’s nominee to lead the bank after Campos Neto’s term ends in December.

Galipolo expressed discomfort with the bank’s inflation models indicating consumer prices exceeding the annual 3% target and suggested a rate hike was probable.

Brazil’s 12-month inflation hit 4.24% in August. The central bank revised its baseline inflation forecasts to 4.3% for this year and 3.7% for 2025, up from 4.2% and 3.6% previously. For the first quarter of 2026, the projection was 3.5%, increased from 3.4%. In all cases, estimates exceed the 3% target, which has a tolerance margin of 1.5 percentage points on either side.

(This story has been corrected to show that the last interest rate hike was in August 2022, not June 2022, in paragraph 6)