UPDATE 2-Brazil central bank signals more interest rate cuts unlikely

Thu Jan 24, 2013 9:56am EST

* Bank says monetary tools cannot fix economy's shortcomings

* Warns that inflation to remain resilient in short term

* Hawkish stance surprises some analysts, see rates on hold

By Alonso Soto

BRASILIA, Jan 24 (Reuters) - Brazil's central bank signaled on Thursday that further interest rate cuts are unlikely because they won't solve the causes of the country's economic slump, sending a strong message to investors that inflation remains its top priority.

The bank acknowledged for the first time that interest rate cuts might prove ineffective to fight the bottlenecks and the production gaps that are weighing on the world's No. 6 economy.

In the minutes from its last rate-setting meeting on Jan. 16, the bank said that the economic recovery has been painfully slow "essentially due to limitations on the supply side."

It added that monetary policy is unable to address those issues because it is a tool meant to control demand.

That more hawkish language was taken as a signal that the central bank will keep rates at the current 7.25 percent for a long time or even hike them later this year or early in 2014.

Without further help from the central bank to foster growth, President Dilma Rousseff may find it more difficult to regain the above 4 percent growth rates that made Brazil an emerging market darling among investors. Another disappointing economic year could jeopardize the chances of her Workers Party to be re-elected in 2014.

Since August 2011, many economists believed the central bank was focused more on stimulating economic growth than controlling inflation, as it cut 525 basis points off its Selic rate.

Now that inflation is picking up fast, the bank is trying to regain its inflation-fighting credentials, analysts said.

"If cutting interest rates is not enough to revamp the investment cycle then there is a political issue that has to be solved and the central bank cannot do anything about that," said Cristian Maggio, emerging market strategist for TD Securities.

"The overall message that the bank is sending out is that rates will remain stable despite the slower than expected growth which is entirely counterbalanced by the fact that inflation has deteriorated more than they were initially expecting."

Brazil's interest future contracts rose across the board after the release of the minutes on Thursday as traders saw few chances of a rate cut any time soon.

Central bank chief Alexandre Tombini late on Wednesday hinted to investors at the World Economic Forum in Davos that the bank will not hesitate to hike rates to control inflation.

"The central bank remains vigilant and will do what it has to do to handle monetary policy in Brazil. We will control inflation, as has been the case over the past nine years," Tombini said, according to excerpts of a recording of his speech provided by the central bank's press office.

PRICE SPIKES, SUPPLY WOES

The bank warned that inflation will remain "stubborn" in the short term due to a reversal in tax breaks and seasonal pressures on transportation, the minutes added.

The bank said that future rate decision will aim to assure the convergence of inflation toward the official target in a "timely manner."

Inflation rose faster in the month to mid-January than most analysts expected, reaching an annual print of 6.02 percent, according to data released on Wednesday. That is well above that of regional peers like Mexico and Chile, whose economies are growing at a much faster pace.

The bank's inflation estimate for 2013 rose since its last meeting in November and remains above the center of the target range of 4.5 percent, the minutes said, without specifying its forecast inflation for this year.

That higher inflation projection takes into consideration a projected 5 percent increase in gasoline prices this year and a reduction of about 11 percent in electricity rates for household consumers.

That projection is now outdated after the government on Wednesday confirmed that residential consumers will pay 18 percent less for power.

A government source told Reuters on Monday that the bank estimates that the cut in electricity prices should shave a full percentage point off consumer inflation by the end of 2013.

Rousseff's announcement on Wednesday of the deeper-than-expected energy cuts could ease inflation expectations ahead.

The cut in energy fares also aims to support an economy that has struggled to grow since Rousseff took office in 2011.

The Brazilian economy is suffering from deeper problems linked to supply bottlenecks such as inadequate infrastructure, high taxes and burdensome red tape.

A World Economic Forum report on trade said that managing customs paperwork for exports of agricultural commodities can take more than 12 times longer in Brazil than in the European Union. It also flagged barriers for industries as diverse as high tech, handset and chemical due to Brazil's unsafe business environment, complex tax system and steep custom requirements.

An improvement in infrastructure and removal of other trade barriers could increase Brazil's economy by 3.6 percent and raise its exporters 30 percent, the report said.

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