(Bloomberg) -- Brazil’s annual inflation slowed much more than expected in May, hitting the lowest level in two and a half years and piling pressure on the central bank to ease monetary policy in coming months.

Official data released Wednesday showed consumer prices rose 3.94% from a year earlier, less than all forecasts in a Bloomberg survey of analysts that had a 4.04% median estimate. Monthly inflation stood at 0.23%.

Swaps rates on the contract due on January 2024, which indicate investors’ sentiment toward monetary policy at the end of this year, dropped six basis points in morning trading as investors weighed odds that borrowing cost cuts could begin soon. The real fell 0.2% to 4.9210 per dollar.

The Brazilian economy started the year with surprising strength in the face of high interest rates. But President Luiz Inacio Lula da Silva is demanding central bankers start cutting borrowing costs to aid his efforts to stimulate growth and improve living standards for workers.

Read more: Brazil’s Economy Roars Back Under Lula and Defies High Rate

The central bank, led by Roberto Campos Neto, applied one of the world’s most aggressive interest rate-hiking campaigns following the pandemic. After taking the benchmark Selic to 13.75%, its highest level in six years, policymakers have yet to show any willingness to start easing despite a spate of better-than-expected inflation data in recent weeks.

But many market observers saw Wednesday’s print as evidence that cuts were imminent. “This paves the way for the start of a cycle of falling rates,” said Carla Argenta, chief economist at CM Capital, an asset manager in Sao Paulo.

Seven of the nine basket groups of goods and services tracked by the statistics agency saw price increases in May. Transport costs fell 0.57% and household goods declined 0.23%, aiding the inflation slowdown. 

What Bloomberg Economics Says

“Slower-than-expected May inflation may fuel optimism on rate cuts in Brazil, but the CPI breakdown still warrants caution on the policy outlook. Underlying inflation ticked down, but likely not enough to sway the central bank just yet.”

— Adriana Dupita, Brazil and Argentina economist

— Click here to read the full report

In May, state-controlled oil giant Petrobras changed its fuel-pricing policy leading to sharp drops in the cost of gasoline and diesel. Lula, 77, who took office for his third term in January, has long argued for a larger government role in the economy to protect the country from price shocks and adverse conditions.

Read more: Petrobras Eases Fears of Fuel Intervention in Policy Shift 


The central bank, however, is autonomous from the executive branch and has largely brushed off the leftist leader’s calls for looser monetary policy.

Even with inflation easing for 11 straight months — close to the bank’s targets of 3.25% for 2023 and 3% for 2024 — policymakers maintain that it’s too soon to lower rates. Fearful that another bout of price gains is on the horizon, board members insist on patience as they try to slow down the economy further and hit long-term consumer-price goals. 

That stance has led to frequent protests from Lula and some of his closest aides, who say the monetary authority is causing unnecessary pain on the population.

With tight credit conditions biting and political pressure building, many analysts believe the bank’s argument for holding rates is weakening — especially as price pressures seem set to keep easing.

“The improving inflation outlook, real strengthening and stabilizing inflation expectations should support a monetary policy pivot in two-three months,” Alberto Ramos, chief economist for Latin America at Goldman Sachs & Co, wrote in a research note.

--With assistance from Giovanna Serafim, Rafael Gayol and Josue Leonel.

(Recasts lead paragraph, adds analysis and context on central bank throughout.)

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