* Central bank hikes Selic by 50 bps as expected
* Bank says hike to help lower inflation through next year
* Currency, fiscal discipline key in tightening cycle
By Alonso Soto
BRASILIA, July 10 (Reuters) - Brazil raised its benchmark interest rate to 8.50 percent from 8 percent on Wednesday, maintaining the pace of monetary tightening to battle 20-month high inflation that is undermining growth in Latin America's largest economy.
The central bank's monetary policy committee voted unanimously to hike its Selic rate by 50 basis points to a 14-month high, a move widely expected by markets.
Rising prices have already started to erode Brazilians' purchasing power, threatening the popularity of President Dilma Rousseff who is trying to appease a nationwide movement against poor public services and corruption sparked by a hike in bus fares last month.
Under the leadership of Alexandre Tombini the central bank has hiked rates three consecutive times this year in a bid to regain its credibility as an inflation fighter and curb prices.
"Firmer action from the central bank helps restore some of the policy confidence in Brazil, but they still have a long way to go," said Robert Wood, the Brazil economist for The Economist Intelligence Unit. "The weakening of the currency will feed into inflation... the central bank is aware of the unfavorable inflation dynamics and is acting to contain prices."
A sharp depreciation of the real, which increases the value of imports, poses a serious challenge for the central bank, which has pledged to bring inflation below the 5.84 percent mark recorded last year.
"The Committee understands that this decision will contribute to lowering inflation and ensuring that the trend continues next year," the central bank said in a statement, repeating the same language used in the previous decision.
Rousseff, who is widely expected to run for re-election next year, has promised to increase investment in public services but at the same time maintain fiscal discipline to regain the confidence of investors after two years of subpar growth.
In a nod to the central bank, the administration has said it is putting the final touches in a budget cut of up to 15 billion reais ($6.63 billion).
MORE HIKES AHEAD
Fiscal prudence and the exchange rate level will be key to determine how far the central bank will go in the current tightening cycle, which some economists say could bring the Selic back to double digit levels.
"I see them continuing the pace of 50 basis points as they did not give any indication otherwise," said Gustavo Mendonca, an economist with Saga Capital in Rio de Janeiro.
The central bank stepped up the pace of tightening in May with a surprise 50-basis-point increase, a key inflection point in its monetary policy as an economic recovery in the United States reduced disinflationary factors from abroad.
A possible cut in stimulus by the U.S. Federal Reserve has sparked an exodus of U.S. dollars from emerging-market nations such as Brazil, pressuring their currencies and raising the value of their imports.
A senior government official told Reuters on Tuesday that monetary policy "will have to be more restrictive" to make up for the expected withdrawal of U.S. stimulus.
Annual inflation climbed at the fastest pace in 20 months in June at 6.70 percent, way above the ceiling of the official target of 4.5 percent -- plus or minus two percentage points.
Still, the monthly print came in below market expectations, supporting hopes that increases in consumer prices could start to slow.
Last month the central bank sharply raised its own inflation estimates for 2013 and 2014, but signaled it will act aggressively to meet its own goal of bringing inflation below the 5.84 percent mark posted last year.