In May 2016, we radically changed our forecasts in light of a change in government. Our end-2017interest rate call of 9% at the time was met with much scepticism (please see, Brazil: Andnow for something completely different). Since then, the market consensus forecast has steadilydrifted our way. In fact, having been chased by consensus, we subsequently cut our terminalrate call to 8% (see Brazil’s rates: Aim lower), and then to 7% (see Brazil’s rates: Themagnificent seven). Again, our once-bold rate call has become quite popular now (see Chart 1).    That worries us. While we love becoming consensus, we hate being consensus. For now, westop short of cutting our rate call yet again, given lingering uncertainties. Still, we strongly thinkrisks around our 7% rate call are biased to the downside, not upside. We would not be surprisedat all if the terminal policy rate in the current monetary easing cycle has a 6% handle.    We see strong cyclical reasons for our rate call. First, Brazil’s real interest rates have averagedroughly 5% over the past 10years. With prospective inflation in the 3%-4% range, even a“neutral” real interest rate of about 5% would imply a neutral nominal rate in the 8%-9% range.    Second, policy rates swing well beyond “neutral” over the cycle. In easing cycles, rates shouldfall below neutral. This is especially true today, in light of the huge output gap left by Brazil'sworst recession on record, and longer-run inflation expectations that are remarkablyre-anchored back to target, now that policymakers have managed to re-build previously lostcredibility.    In order to gauge the role played by cyclical factors in determining Brazil’s policy rate, we haveestimated econometrically a Taylor rule for Brazil. It shows Brazil’s expected monetary policyreaction function in response to the output gap (growth deviations from potential) as well as tothe inflation gap (deviations of inflation expectations from official targets).    The fit of the model is significant – in fact, deviations from actual policy rates from the model’sprediction during the latter years of the Dilma Rousseff administration illustrate how monetarypolicy during those days was much looser than objective conditions would justify.    All things considered, taking into account cyclical prospects for inflation and growth, our Taylorrulemodel currently indicates that the policy rate could easily fall to the 6%-7% range,supporting our view that risks around our current 7% terminal rate call are to the downside. Insum, when it comes to prospects for the terminal rate call, six is now in the mix.

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