Brazil poised to keep rates steady, may hint hikes ahead

Wed Mar 6, 2013 12:59am EST

* Brazil seen keeping benchmark Selic rate at 7.25 pct

* Bank likely to signal rate hike in decision statement

* High inflation takes priority over slow-moving recovery

By Alonso Soto

BRASILIA, March 6 (Reuters) - The Brazilian central bank will likely keep interest rates at record lows for a third straight meeting on Wednesday, but could signal it is ready to hike borrowing costs soon to tame high inflation.

The bank's monetary policy committee, known as Copom, meets to decide on its benchmark Selic rate as inflation fears start to outweigh concerns of a feeble recovery in Latin America's largest economy.

Inflation is moving close to the 6.5 percent ceiling of the official target range, raising concerns that high inflation could not only undermine the recovery but the re-election chances of President Dilma Rousseff next year.

All of the 56 analysts polled by Reuters last week agree that the central bank will keep rates unchanged at 7.25 percent. However, most of them say the bank, in an effort to control rising inflation expectations, could remove its reference to stable rates "for a sufficiently prolonged period" in its decision statement.

"The bank will keep rates on hold and move the statement to a more decisive hawkish tone," Ilan Solot, a strategist with Brown Brothers Harriman wrote in a research report. "If inflation trends don't start to improve very soon, hikes could start as early as the April 16/17 meeting."

Central bank chief Alexandre Tombini said in February he is "uncomfortable" with current inflation levels and that the bank will not hesitate to raise rates to control prices.

The bank has come under growing pressure to show it is committed to battle inflation even as the economy continues to disappoint. Inflation is expected to climb to 6.20 percent in February, according to a Reuters poll published n Tuesday.

Under Tombini the bank has been at the forefront of the government's crusade to revive the economy, slashing 525 basis points off the Selic in a little over a year as part of a slew of measures to bolster consumption.

Now the central bank faces the difficult balancing act of keeping rates at a level that allows for activity to pick up while at the same time tames inflation.

Tombini has said he expects inflation to ease in the second half of the year due to a more stable local currency, subdued food prices and government-sponsored cuts in electricity rates.

"What seems clear is that there is currently very limited tolerance by the central bank for additional inflation surprises," Alberto Ramos, senior economist for Goldman Sachs, said in a note. "Any small deviation from the central bank path, or deterioration of inflation expectations will likely trigger rate hikes, in our view."

SMALLER RATE HIKES

President Dilma Rousseff has claimed record low rates as one of the main political victories of her government as she reaches the mid-point of her presidency with an economy that is struggling to grow.

Meager economic growth of 0.9 percent in 2012 will likely keep the central bank from tightening policy in the near term or hiking rates too much this year, some analysts say.

Tombini has acknowledged that any future rate increases will be limited in scope as the Brazilian economy has reached a new level of maturity with solid fundamentals.

Rates above 10 percent "would not only play havoc with one of the few developments that the current administration can claim as an accomplishment on the economic front, but would also decelerate growth substantially precisely on the eve of next year's election," said Alexandre Schwartsman, a former central bank director and partner with Schwartsman & Associados.

Market investors expect rates to rise above current levels. Yields of the interest rate futures contract that expires on Dec. 30, which reflects market expectations for the Selic rate at the end of the year, rose six basis points to 7.7 percent on Tuesday.

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