UPDATE 2-Brazil hints at rate hikes to curb currency inflation impact

Thu Jul 18, 2013 10:30am EDT

* Central bank says weak real may stoke short term inflation

* Policymakers vow to limit impact of weaker real on prices

By Alonso Soto

BRASILIA, July 18 (Reuters) - Interest rate increases will help limit the inflationary impact of a rapid weakening of Brazil's currency, the central bank said on Thursday, signaling policymakers are likely to keep up the pace of monetary tightening to tame price increases.

The central bank's monetary policy committee unanimously voted to hike its benchmark Selic rate by 50 basis points to 8.50 percent last week in what is considered one of the most aggressive monetary tightening cycles in the world.

The bank has already raised its benchmark rate by a cumulative 125 basis points since April to curb inflation. In the 12 months through June, consumer prices rose 6.7 percent -- piercing the bank's 6.5 percent annual target ceiling.

In the minutes of last week's meeting, policymakers reiterated they will remain vigilant on price trends in Brazil, although they acknowledged the country's economic recovery is running into speed bumps.

The central bank warned that the depreciation of the country's currency, the real, could fan inflationary pressures in the short-term, a process commonly known among economists as currency pass-through. When a currency depreciates, prices of imports rise for domestic consumers.

"The side effects arising from it (currency depreciation), which tend to materialize over longer periods, may and should be limited by appropriate monetary policy," the bank said in the minutes.

Following the release of the minutes, yields on interest-rate futures contracts showed that a majority of investors are pricing in another 50-basis-point increase in the Selic when the bank's monetary policy committee agains meets on Aug. 28.

In foreign exchange markets, the real firmed 0.14 percent to 2.22 per dollar. However, so far this year, it has depreciated 7.9 percent, posting a sharper fall against the dollar than most of the world's most-traded currencies, according to Reuters data.

"The real may play a key role in the calibration of monetary policy as a substantially weaker currency could force the central bank to extend the hiking cycle in order to limit the pass-through to domestic prices and anchor inflation expectations," Alberto Ramos, head of Latin America economics research with Goldman Sachs Group, said in a note to clients.

In the minutes the bank removed previous reference to an "unfavorable" inflation outlook. However, analysts say the recent drop in inflation explains why the bank scrapped that warning.

Recent price indicators show inflation has started to ease. The market expects inflation to ease to 6.43 percent in the twelve months through mid July, back to within the official target range, according to a Reuters survey of 16 economists. The data will be released on Friday at 9 a.m (1200 GMT).

CURRENCY IS THE KEY

"You have a balance here. In the exchange rate front the bank was more hawkish, but on the growth front it turned out more dovish," said Gustavo Rangel, chief Latin America economist with ING Bank NV in London, said after the release of Thursday' minutes.. "There is no real sense that they are prepared to change course ... I think another 50-basis-point (hike) is certain."

While most central banks are cutting borrowing costs as global inflationary pressures fall, policymakers in Brazil are tightening policy to curtail a surge in prices stemming from rampant government spending, and a leap in household income that outpaced productivity gains and rising prices for some services.

Last month the central bank sharply raised its own inflation estimates for 2013 and 2014, but signaled it would act aggressively to meet its own goal of bringing inflation below the 5.84 percent mark posted last year.

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