UPDATE 2-Market sees smaller Brazil rate hike after Tombini remarks

Tue Feb 18, 2014 1:04pm EST

By Alonso Soto

BRASILIA Feb 18 (Reuters) - Traders of Brazilian interest rate futures changed bets and expect authorities to opt for a smaller rate hike after central bank chief Alexandre Tombini said policymakers have been doing their "homework" in fighting inflation.

Market traders interpreted Tombini's comments to mean the bank may not need to keep up the aggressive pace of monetary tightening to slow inflation.

"We are not new in this process, we have been doing our homework to fight inflation and to a large extent we have been successful," said Tombini, referring to policies used to prepare the country for tighter monetary policy in developed economies.

Tombini also stressed that the central bank will keep a close eye on inflation, saying that there are many tools to battle price increases. However, he hinted interest rate will remain the preferred instrument to control prices.

Under Tombini the central bank has raised interest rates by 325 basis points since April to 10.50 percent, quickly lifting borrowing costs from record lows to battle a surge in prices.

Until recently, market traders expected the bank to opt for another 50-basis-point rate increase at its next meeting on Feb 26. However, the probability of a 25-basis-point rate hike implied in the rate futures curve increased to 61 percent after Tombini's comments, according to Thomson Reuters data .

"Many interpreted his comments to mean the bank will rely on other tools to battle inflation instead of rate hikes, but I don't agree with that view," said Andre Perfeito, chief economist with Gradual Investimentos in Sao Paulo. "For the central bank to control long-term inflation expectations it needs to raise rates by 50 basis points."

Tombini said that the monetary tightening has had some impact on inflation, but repeated that the policy operates with some lags and that more effects would be felt later.

Inflation has eased to the lowest in around a year, but remains at the upper end of the official target range between 2.5 percent and 6.5 percent. Inflation likely rose 5.63 percent in the 12-month period through mid-February, according to a Reuters poll of economists.

Tombini said he did not expect Brazil to have fallen into recession in late 2013 or that it would do so in 2014 despite recent data indicating that the economy may have contracted for two straight quarters, the definition of a technical recession.

Tombini acknowledged that the economy may have grown less than the central bank's 2.3 percent forecast for 2013, but said conditions are improving, with more investment flowing into infrastructure projects in coming quarters.

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