UPDATE 5-Brazil opts for deeper rate cut to stoke recovery

Wed Mar 7, 2012 10:24pm EST

* Central bank slashes rate to 9.75 pct from 10.50 pct

* String of weak economic data likely influenced decision

* Analysts expected 50 bps rate cut, traders saw 75 bps

* Bank directors divided 5 to 2 over rate cut

By Alonso Soto and Tiago Pariz

BRASILIA, March 7 (Reuters) - Brazil slashed interest rates by a larger-than-expected 75 basis points on Wednesday, stepping up its battle to revive struggling industries that threaten to derail the recovery of Latin America's largest economy.

In its boldest move since August, when it surprised markets and began the current round of cuts, the central bank lowered its benchmark Selic lending rate to 9.75 percent from 10.50 percent in a split decision.

Two of the bank's seven directors wanted to lower the rate by half a percentage point for the fifth straight meeting.

It was only the second time on record that Brazil has cut the Selic below 10 percent, taking borrowing costs to their lowest level in nearly two years.

Directors made the decision hours after data showed industrial output fell nearly three times more than economists had expected, the latest indicator to suggest Brazil's boom is fizzling.

Central bank chief Alexandre Tombini is treading a fine line by trying to bolster economic growth without rekindling inflation, which has slowed this year after finishing 2011 at 6.5 percent, the highest year-end level in seven years.

By accelerating the pace of interest rate cuts, President Dilma Rousseff's administration hopes to shield Brazil's recovery from a strong local currency that economists and business leaders say is crippling its industrial base.

"Generally the central bank slows the rhythm (of interest rate cuts) when it's near the end of a cycle, but now it's accelerating. We can expect more cuts to the Selic rate," said Eduardo Velho, chief economist with Prosper Brokerage.

Traders successfully predicted the steeper rate cut. But most analysts had expected a 50 bps reduction, believing Tombini would opt for a somehwat more cautious approach to anchor inflation expectations even as pressure mounted for policymakers to do more to jumpstart the economy.

"Continuing the process of adjusting monetary conditions, the Copom decided to lower the Selic rate to 9.75 percent," the bank said in an unusually short statement accompanying its decision.

Signs of an incipient recovery in Brazil, coupled with a slew of new government measures to stimulate growth, could again put pressure on inflation that remains naggingly high.

Faster rate cuts could pressure inflation expectations as they did in the months after rates reached similar lows in 2009-2010. At that time the government was battling to maintain growth in the wake of the U.S. banking crisis.

Inflation expectations for 2013 have risen for three straight weeks, a central bank survey of economists showed.

RECOVERY RISKS

Official data on Tuesday showed Brazil's economy grew just 2.7 percent in 2011 and barely avoided a recession in the second half of the year. That was a far cry from 2010, when the economy grew 7.5 percent, the fastest pace in more than two decades.

Rising global oil prices and lower growth in China, Brazil's largest trading partner, could further hamper an economy that is already dealing with high taxes, a tight labor market and weak infrastructure.

Tombini has warned recently of the risks to the recovery stemming from a resurgence of foreign capital inflows that bolstered the value of the real. The currency gained around 8 percent in the first two months of the year.

"This decision had to do with the connection between interest rates and foreign exchange and the government's inclination to help industrial competitiveness by weakening the currency," said Tony Volpon, head of Americas emerging markets research at Nomura Securities, of Wednesday's rate cut.

Industries ranging from auto makers to shoe and food producers have been hit by the strong real, raising their costs and flooding the local market with cheaper imports from abroad.

MORE CUTS AHEAD

Rousseff has taken measures to try to limit what she calls a "tsunami" of cheap money from rich nations. Cash has flooded into emerging market nations from richer ones to take advantage of higher benchmark rates.

In response, the central bank has stepped up interventions in the currency market to prevent the real from strengthening further and undermining competitiveness of local industry.

In theory, lower rates would help limit capital inflows by reducing the returns of investors seeking higher profits in emerging markets. But even at 9.75 percent, Brazilian interest rates would remain among the world's highest.

Benchmark rates in the United States are near zero.

Easing Brazilian inflation is likely to allow for more rate cuts ahead, but the pace will also depend on the health of the economy.

Inflation slowed to an 11-month low of 6.22 percent in January. Analysts see annual inflation easing further to 5.84 percent in February.

Tombini had already said the Selic rate could fall to single digits and signaled the easing cycle may continue further by saying the economy is growing below potential, which means there is room for more rate cuts without risking runaway inflation.

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