BRASILIA, Dec 20 (Reuters) - Brazil's central bank expects inflation to slow only slightly in the next two years despite steep interest rate hikes, leaving the door open for additional increases before putting an end to the aggressive tightening cycle next year.
In its quarterly inflation report released on Friday, the bank trimmed 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 only slowly moving toward 4.5 percent, the center of its 2.5 percent to 6.5 percent target range.
Central bank director Carlos Hamilton Araujo reinforced the message that policymakers could keep raising rates by saying that the bank "will keep an eye on the battle against inflation."
Araujo repeated that phrase at least five more times during a two-hour press briefing, changing from his previous message that there was "a lot of work to be done" to bring down inflation. He added that the bank's inflation estimates could improve in the future.
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."
Other analysts believe the bank sounded more aggressive in the report and could opt to extend the rate-hiking cycle further than previously expected.
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, signaling it expects less market volatility ahead.
Inflation rose more than expected to 5.85 percent in the 12 months to mid-December, putting in doubt the central bank's pledge to keep inflation in 2013 below last year's mark of 5.84 percent.
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 nearly 1.5 percent on Friday after the report was released to 2.3840 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 again said that it sees conditions for the government's fiscal policy to move toward neutrality next year. That stance has been widely criticized by the market, which sees fiscal policy remaining expansive next year.
The bank said that the country needs to generate primary surpluses similar to the average of recent years to keep its public debt at a sustainable level. In the past Brazil has had higher primary surpluses, or extra revenue before debt payments, closer to 3 percent of GDP.
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.