By Alonso Soto and Silvio Cascione

BRASILIA (Reuters) - Brazil surprised markets with a larger-than-expected interest rate cut on Wednesday, as the worst recession in Brazilian history threatens to stretch into a third year.

In a unanimous vote, the central bank's nine-member monetary policy committee, known as Copom, decided to cut its benchmark Selic rate <BRCBMP=ECI> by 75 basis points to 13.00 percent after two straight cuts of 25 basis-points each.

An overwhelming majority of analysts had expected a rate cut of 50 basis points with only a few predicting a more aggressive monetary easing that brought rates to a near two-year low.


The surprise decision could help President Michel Temer breathe new life into the economy amid lingering political tensions, following last year's impeachment of President Dilma Rousseff, and a corruption investigation involving his own party.

In its post-meeting statement, the bank said it had considered a 50 basis points cut but decided to frontload the monetary easing as widespread disinflation and a halting recovery called for more aggressive action.

"The extension of the cycle and possible revisions of the pace of easing will continue to depend on inflation forecasts and expectations," said the bank, pointing to evidence that the recovery could take longer and be more gradual than expected.

In an unusual statement following the decision, Temer said the drop in rates showed the conditions for a recovery were in place and that there was room for more rate cuts.

The recession, the worst in Brazilian history, has left millions unemployed and bankrupted hundreds of companies, raising pressure on central bank chief Ilan Goldfajn to lower rates, which rank among the world's highest.

The sharp slowdown in inflation, which ended 2016 below the 6.5 percent target ceiling after starting the year at double digits, paved the way for the central bank to slash rates.

In its statement, the bank lowered its 2017 inflation forecast to 4 percent, below the 4.5 percent midpoint of the official target. For 2018, it sees inflation slowing further to 3.4 percent.


The bank will likely maintain an aggressive pace of rate cuts for at least its next two meetings as a disappointing recovery of the once-booming economy will keep dragging down inflation, analysts said.

"The Copom will likely take advantage of the more favorable inflation outlook to quickly ease monetary policy," Jankiel Santos, chief economist with Haitong, an investment bank in Sao Paulo. "The chances of a single-digit Selic rate by the end of this year have grown a lot."

Annual inflation slowed to 6.29 percent in 2016, down from an increase of 10.67 percent in the previous year with inflation in the service industry starting to ease after some past resistance.

The bank's decision was applauded by business groups that for years have called for lower rates to jump-start activity.

Shortly after the rate decision, Brazil's No. 2 private bank Bradesco <BBDC4.SA> and biggest lender, state-run Banco do Brasil <BBAS3.SA>, announced they were going to cut rates to be more in line with the Selic.

Still, a more robust recovery will remain elusive, according to some economists.

"This is an aggressive easing cycle. But political uncertainty is limiting the recovery in investments, and the fact that the labor market is very deteriorated is hindering the recovery in consumption," said Juan Jensen, partner with E4 consultancy.

Temer, who took over the presidency last year after Rousseff's dismissal, is expected to rely on rate cuts as a fiscal crisis limits his ability to provide other stimulus.

If Temer succeeds in passing a reform to slash pension benefits, which represent nearly half of the country's expenditures before debt-servicing costs, interest rates could fall further, government officials have said.

The median Reuters poll forecast for the Selic rate at the end of 2017 stood at 10 percent in the poll, with estimates varying between 9 percent and 11.25 percent.

(Reporting by Alonso Soto; Editing by Paul Simao and Tom Brown)