MercoPress. South Atlantic News Agency

Brazil ups basic rate to 8.5% to combat inflation; markets forecast 9.25%/10% by end of the year

Tombini said the ‘same intensity’ in rate increase can be expected in August’s Copom’ meeting

Brazil’s central bank raised the benchmark interest rate a third consecutive time and anticipated that the tightening cycle may be extended through the rest of the year as policy makers fight inflation.

The bank’s monetary policy committee, Copom, late Wednesday announced the increase of the benchmark Selic by 50 basis points to 8.5%. Brazil’s inflation is running at 6.7% above the 12-month 4.5% target and some analysts forecast three further increases before the end of the year.

Brazil is one of several emerging economies raising interest rates taking steps to stem capital outflows sparked by concern the U.S. Federal Reserve will start to scale back liquidity injections.

After a quarter-point rate increase in April, policy makers in Brazil doubled the pace in May and reiterated warnings that the outlook for inflation remains unfavorable.

In a very brief and unanimous release the Central bank headed by Alexandre Tombini said that the same intensity in the increase of interest rates can be expected at the next meeting at the end of August. The adjustment of the basic rate is a decision that “will contribute to put inflation on a decline and assure that this trend will persist next year.”

A dimming outlook for emerging markets prompted the IMF this week to cut its global growth forecast for 2013 to a “subdued” pace of 3.1% and for emerging economies to 5% from 5.3%, while dropping the outlook for Brazil to 2.5% from 3.4%.

Since May 29, when Brazil’s government reported that growth of GDP unexpectedly slowed to 0.55% in the first quarter, a number of key economic indicators have missed expectations.

Retail sales, which helped propel Brazil’s economic expansion in recent years, were unchanged in May from April, the national statistics agency said. Likewise industrial output declined 2% in May.

Brazil’s Ibovespa has declined 31.4% in dollar terms in 2013, the worst performance among 94 global benchmark indexes after the Lima General Index. The Hang Seng China Enterprises Index has dropped 16.5%

Local currency Real has weakened 12.9% in the past three months and stands at 2, 20 to the US dollar. The Real depreciation pushes up the price of some imports and threatens to further fuel inflation that helped spark nationwide demonstrations last month.

“Future steps of the Central bank will much depend on the performance of the US dollar: if the rate remains at 2.10 to the US dollar, maybe just one increase may be enough to keep inflation in rein”, said former central banker Carlos Thadeu de Freitas.

But if this does hot happen, Frietas said that “the basic rate could climb to 10%”.

The weekly Focus bulletin indicates that a majority of the one hundred interviews done by the central bank believe Copom will implement two further rate increases taking the Selic rate to 9.25% by the end of the year. But the Itau-Unibanco expects three more increases and a 9.75% rate.

Central bank president Tombini has pledged that inflation this year will be below last year’s 5.84% and in 2014, below 5%. To support this policy the Finance ministry is planning to trim expenditures taking the budget primary surplus to 2.3% of GDP this year. However markets so far are sceptical and estimate that the government will only manage a primary surplus of 1.7% of GDP.