BRASILIA, Dec 20 (Reuters) - Brazil's central bank expects inflation to slow slightly in the next two years while economic growth remains moderate, leaving the door open for additional rate hikes before it halts its aggressive monetary tightening cycle.
In its quarterly inflation report released on Friday, the bank kept its 2013 inflation forecast at 5.8 percent. It cut its inflation view for 2014 to 5.6 percent from 5.7 percent.
The bank said it expected consumer prices to rise 5.4 percent in 2015, meaning it sees inflation slowly moving toward 4.5 percent, the center of its 2.5 percent to 6.5 percent target range.
The bank revised down its estimate for economic growth to 2.3 percent this year from 2.5 percent previously. Looking further ahead, it projected the growth pace in the third quarter of 2014 to match the 2.3 percent growth seen for all of 2013.
"Forecasts for slower inflation and stable growth indicate that the tightening cycle is close to its end, but we still don't know when it will end exactly," said Luis Otávio Leal, chief economist with Banco ABC Brasil. "The bank is leaving the door open to extending the cycle."
A third year of sub-par economic growth has raised pressure on the central bank to halt its monetary tightening cycle, which has added 275 basis points to its benchmark Selic rate since April.
Under its chief Alexandre Tombini, the bank raised the Selic by 50 basis points for the fifth straight time to 10 percent in late November, its highest in nearly two years.
A slight majority of market traders are betting the central bank will opt for a 25 basis points rate hike at its next meeting in January. Most economists see the Selic ending the year at 10.50 percent, according to a weekly central bank poll.
Brazilian interest rate futures rose across the board on Friday.
In the report, the bank again stressed that it will remain especially vigilant about high prices and that monetary policy has a lagging effects on inflation.
Tombini warned two weeks ago that the sharp volatility of the local exchange rate could undermine the effect of monetary policy on inflation.
However, the real's so far moderate reaction to the U.S. Federal Reserve's decision on Wednesday to scale back its massive stimulus program could give Tombini and the seven other members of the bank's board more reasons to ease the tightening cycle.
Although the Fed's decision could reduce the supply of dollars seeking higher returns in emerging markets, the capital flight may not be as swift as some feared considering the Fed's suggestion that U.S. interest rates may remain near zero for longer than expected.
The Brazilian central bank on Wednesday also slowed the pace of its forex intervention program.
Inflation remains naggingly high in Brazil, rising 5.85 percent in the 12 months to mid-December and putting in doubt the central bank's pledge to keep inflation in 2013 below last year's mark of 5.84 percent.
Inflationary pressures will likely stay high with price increases widely spread and core inflation remaining high.
The central bank also noted in its report that the 2014 soccer World Cup and 2016 summer Olympics will likely add 2 percentage points to inflation between 2007 and 2017.
The real firmed more than 1 percent on Friday morning to 2.3713 per dollar.
SPENDING AND NEUTRALITY
In the report, the central bank forecast government spending to continue rising rapidly well into 2014, but expected revenues to pick up to balance the country's fiscal accounts.
The central bank was widely criticized in the past for saying that it sees conditions for the government's fiscal policy to move toward neutrality next year.
The rapid deterioration of the country's fiscal accounts, as expenditures grow much more rapidly than revenues, has raised fears Brazil's credit rating could be cut next year.
Central government expenditures have risen 14 percent in the first ten months of 2013, while revenues grew 8.2 percent in the same period, according to official data.