UPDATE 4-Brazil growth slowing sharply, inflation picking up
* Bank hikes 2012 inflation forecast to 5.2 pct from 4.7 pct
* Also cuts 2012 GDP forecast to 1.6 pct from 2.5 pct
* Bank director sees limited room for additional rate cut
By Alonso Soto and Silvio Cascione
BRASILIA/SAO PAULO, Sept 27 (Reuters) - Brazil's central bank slashed its economic growth forecast for 2012 on Thursday, but signaled that it is unlikely to keep cutting interest rates to boost output because inflation is picking up again.
In its quarterly inflation report, the bank forecast that the world's sixth-largest economy would expand just 1.6 percent this year, down sharply from its previous estimate of 2.5 percent, but in line with most market estimates.
The revision highlights President Dilma Rousseff's biggest challenge - restoring Brazil's economy to the glory days of the past decade, when annual growth rates above 4 percent helped lift millions out of poverty and make the South American country a star among emerging markets.
The Rousseff administration has prevented an even deeper slowdown by taking stimulus measures that include tax breaks for targeted industries and a year-long rate-cutting campaign that has brought borrowing costs to an all-time low.
But the easing cycle now looks to be over after the central bank raised its inflation forecast for this year to 5.2 percent from 4.7 percent.
Additional rate cuts could nudge inflation closer to the 6.5 percent ceiling of the government's target range, a result that would provide additional fodder for critics who worry the central bank has pushed inflation targeting to the back burner while it focuses instead on economic growth.
Brazil's economy has been stagnant for much of the past year, hit by fallout from the European debt crisis, slower growth by k ey tradin g p artner China and homegrown problems su ch as a manufacturing sector struggling wit h hi gh taxes and a st ro ng local currency.
Fortunately for the central bank, government plans to reduce electricity rates should help ease inflation pressures in 2013, a year when economic growth could rise back above 4 percent, according to many economists. As a result, the central bank lowered its inflation forecast for next year to 4.9 percent from 5 percent.
Still, both inflation estimates remain well above the center of the official target range of 4.5 percent - plus or minus 2 percentage points.
"The bottom line is that the central bank recognizes that its policy is not helping inflation converge toward the center of the official target and that makes it more likely that the (benchmark) Selic will remain where it is now," said Mauricio Rosal, economist with Raymond James in São Paulo.
While analysts expect the central bank to leave the Selic rate unchanged at 7.5 percent at its next meeting on Oct. 10, investors are somewhat more cautious.
Trading in Brazilian interest rate futures on Thursday implied a 50 percent probability that the bank will leave rates unchanged at the bank's next meeting, according to Thomson Reuters calculations. The other half is betting on a cut of 25 basis points.
Central bank director Carlos Hamilton Araujo, a voting member of the monetary policy committee, added to some analysts' perceptions that the bank is done cutting rates for now.
"The room to continue lowering rates has been reduced," Hamilton told reporters in Brasilia after the release of the inflation report. He added that any immediate efforts to bring inflation back to the center of the target this year would have "high costs" in terms of activity.
In the report, the central bank acknowledged that the path of 12-month inflation toward the center of the target was not linear. In other words, there would be ups and downs before the consumer price index settles around 4.5 percent.
The bank also flagged risks to short-term inflation, saying it "contemplates relatively benign dynamics for food prices in the medium term, although price volatility of raw materials and grains constitutes a risk factor."
For more than two months, the annual inflation rate has moved upward. A rise in food prices pushed inflation up to 5.24 percent in August, reversing a downward trend that took inflation to a near two-year low of 4.92 percent in June.
While the outlook for next year is better, doubts remain whether Brazil's economy can regain the momentum of years past.
Fitch Ratings, which cut its estimate for Brazil's 2012 growth to 1.5 percent, expects the economy to grow 4.2 percent next year. However, it said its 2013 forecast is uncertain, "given the international financial volatility and the pace at which the Brazilian economy responds to monetary and fiscal stimuli."
The central bank did not provide economic growth estimates for 2013 in its quarterly inflation report.
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