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Low interest rate weakens currency, Central Bank’s study shows

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A working paper by Central Bank economists shows that in some circumstances, reductions in the basic interest rate can have significant effects on the devaluation of the exchange rate.According to the estimates of this paper, a surprise one-percentage-point cut in the Selic policy interest rate by the Central Bank’s Monetary Policy Committee (Copom) leads to a currency depreciation of 3.4%.The paper adds to the endless controversy among economists about the role of low interest rates in the weakness and volatility of the Brazilian real in recent years.Economists José Valentim Machado Vicente, Jaqueline Terra Moura Marins and Wagner Piazza Gaglianone examine the impact of the surprises of the Copom decisions on the exchange rate. That is, if the market expects a 50 basis points cut in the Selic rate, but the Central Bank cuts it by 150 bp, what matters, according to the paper, is the difference of 100 bp."Our study points out to a significant effect of Copom’s interest rate decisions on exchange rate returns in Brazil," they conclude.But at the same time, they ponder that more recently, when interest rates fell to single digit levels, the surprise effect has become less significant. According to the authors, however, this result should be interpreted with caution due to the few number of observations available so far to measure this effect.The research, with the title "Impacts of the Monetary...

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