UPDATE 3-Brazil central bank keeps options open, points to prices

Thu Jan 23, 2014 12:36pm EST

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(Adds details of minutes, inflation context)

By Alonso Soto

BRASILIA Jan 23 (Reuters) - Brazil's central bank on Thursday signaled it may not be ready to slow an aggressive cycle of interest rate hikes as stubbornly high inflation continues to worry policymakers.

In the minutes from its monetary policy meeting last week, the central bank said Brazilian inflation has been slightly more stubborn than expected and even revised its inflation forecast upward for 2014. It stressed that wage dynamics will continue to pressure consumer prices.

In the Jan. 15 meeting, the eight-member monetary policy committee surprised most economists by raising its benchmark Selic interest rate by 50 basis points - double the quarter-percentage-point hike the market expected - to 10.50 percent, its highest level in about two years.

At the same time, however, the bank hinted in the statement accompanying the decision that it may start to slow its tightening cycle by saying that the decision to hike by 50 basis points was appropriate "at this moment."

Although economists are divided as to whether the bank will maintain or slow the pace of rates hikes at its next meeting, most agreed that upcoming inflation data will be a key determinant in the minds of policymakers.

"The bank left the door wide open for either keeping or slowing the pace of hikes," said Flavio Serrano, senior economist with Espirito Santo Investment Bank. "The bank is saying that its next move will depend on upcoming inflation data."

Annual inflation slowed to 5.63 percent in the twelve months to mid-January, pushing down the yields of Brazil's interest rate futures <0#DIJ:> as traders pared back bets that the central bank will maintain the aggressive pace of rate hikes at its next meeting.

Looking ahead, most economists say inflation will remain under pressure because of government spending increases combined with a weaker local currency, which raises the value of imports. Administered prices, or prices fixed by the government, are also expected to rise more rapidly this year than in 2013.

At the next monetary policy meeting on Feb. 26, central bank chief Alexandre Tombini faces a tough decision.

Opting for another rate increase may ease inflation, but at the cost of encumbering a stumbling economy. In the third quarter of last year, the economy contracted by 0.5 percent from the second quarter.

POLITICAL IMPACT

As it stands, President Dilma Rousseff, expected to run for re-election in October, potentially faces the twin liabilities of stubbornly elevated inflation and the prospect of near-stagnant growth for this year.

The rapid rise in consumer prices has already dented domestic consumption, which is the country's main growth engine and has underpinned the president's popularity.

A surprise spike in December inflation is believed to have led the central bank to raise rates aggressively last week.

Brazil has struggled to take inflation back to the 4.5 percent midpoint of the central bank's official target range of 2.5 percent to 6.5 percent.

Despite overcoming hyperinflation in the mid-1990s, Brazil's economy continues to suffer from high inflation when compared to its regional peers.

A combination of high public spending levels, high indexation of prices in local contracts and steep minimum wage increases has kept inflation above 4.5 percent since 2008.

PRIMARY SURPLUS IN FOCUS

In the minutes, the central bank sent a strong message for the government to keep its primary budget surplus high this year to maintain the downward trend of the country's debt burden.

"It is important to point out that the generation of primary surpluses at levels close to the average levels of recent years should help reduce the cost of public debt financing," the central bank said in the meeting minutes.

The country's finances have deteriorated in the past two years as the Rousseff government increased public spending but gave businesses a flurry of tax breaks, which have done little to reignite the economy.

A pick-up in government spending has contributed to higher inflation and stoked fears of a debt downgrade later this year.

Rousseff has repeatedly promised to keep a lid on spending this year to convince investors that her government has not abandoned fiscal discipline. In February, the government is expected to announce a new fiscal savings goal for 2014. (Additional reporting Silvio Cascione and Anthony Boadle; editing by Todd Benson and G Crosse)

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