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UPDATE 3-Brazil cuts rates to record low as economy stalls
May 31, 2012 / 12:25 AM / 5 years ago

UPDATE 3-Brazil cuts rates to record low as economy stalls

* Central bank cuts Selic rate to 8.50 pct from 9 pct

* Weak economic recovery prompts 7th straight rate cut

* Lower interest rates a priority of Rousseff gov't

By Alonso Soto

BRASILIA, May 30 (Reuters) - Brazil's central bank cut interest rates on Wednesday for the seventh straight time to a record low 8.50 percent, moving into uncharted territory in a bid to shield a fragile recovery from a gloomy global outlook.

President Dilma Rousseff has made lower interest rates one of the top priorities of her government, which is struggling to steer the economy back to the 4 percent-plus growth rates that made Brazil one of the world's most attractive emerging markets in the last decade.

Despite concerns among some investors over inflation, the central bank's monetary policy committee, known as Copom, voted unanimously to lower the benchmark Selic rate 50 basis points from 9 percent. That was in line with market expectations and represented a more conservative cut than the 75 basis-point reduction at the last rate-setting meeting in April.

"At this moment, Copom believes that the risks to the inflation outlook remain limited," the bank said in a statement that accompanied the decision. The statement used the exact same language as the previous statement in April.

With Wednesday's cut, the central bank has now lopped 400 basis points off the Selic rate since August 2011, when it surprised markets by starting an easing cycle despite widespread concerns at the time about surging consumer prices.

Inflation has eased since then with some help from a sluggish global economy, bringing the rate to 5.05 percent in the 12 months through mid-May - well below the 6.5 percent ceiling of the central bank's target range.

That has allowed the central bank to test the boundaries on interest rates, ushering in what some economists predict might be a new era of lower borrowing costs for Brazil.

Wednesday's rate cut marked a slowdown in the pace of easing after two straight reductions of 75 basis points in March and April. The central bank signaled after its April policy meeting that future rate cuts might be more cautious.

The previous low for the Selic was set in 2009, when the central bank in the administration of former President Luiz Inacio Lula da Silva slashed the rate to 8.75 percent to fend off the global financial crisis.

Growing fears of a Greek exit from the euro and a global credit crunch will likely prompt more rate cuts by the central bank as it tries to aid government efforts to revive activity.

"The central bank did what was expected, highlighting the external environment," said Silvia Matos, an economist with the Brazilian Institute of Economics at the Getulio Vargas Foundation.

"The bank also showed that it is not bothered with inflation, this is not a problem for them. I think it's very clear that the bank will keep cutting the Selic."

Some economists worry the bank is overlooking high inflation expectations for next year to focus on economic growth now.

Since taking office in January 2011, Rousseff has sought to bolster Brazil's economy with a barrage of tax breaks and credit incentives for targeted industries, with the latest measures benefiting automakers.

Rousseff is also trying to create conditions for Brazilian interest rates - long among the world's highest - to continue falling by keeping a lid on public spending and pressuring banks to lower rates on both corporate and individual loans.

In a politically sensitive move, her government recently scrapped the fixed rate of return on domestic savings accounts, removing one of the main obstacles preventing interest rates from falling further.

For the last century, savings accounts carried a fixed return of about 6 percent annually, which, once tax incentives and other factors were taken into account, amounted to a de facto floor for the Selic rate at its current level.

Brazil's high interest rates are a legacy of the days of runaway inflation in the late 1980s and 1990s, a traumatic era that has left policymakers and politicians of all stripes extremely wary about price stability. The Selic rate hit a record high of 45 percent in 1999, just after Brazil underwent a painful currency devaluation.

MONETARY POLICY LAG

Brazil's economy has been slow to react to the steep drop in borrowing costs and the government's stimulus measures.

Gross domestic product is expected to have expanded just 0.5 percent in the first quarter from the previous quarter, according to the median forecast of 29 analysts surveyed by Reuters. Official GDP data is due out on Friday.

In an interview with Reuters on Monday, Finance Minister Guido Mantega acknowledged the economy could grow 3 to 4 percent this year, down from an initial forecast of 4.5 percent. Brazil grew only 2.7 percent in 2011, behind most regional peers and even Germany.

The slowdown has been a disappointment for an economy that surpassed Britain last year as the world's sixth largest. It has put renewed focus on the need for deeper economic reforms in Brazil to resume higher growth rates.

Central bank chief Alexandre Tombini has said the pace of the recovery is slower than expected, but reiterated that the effects of the easing cycle and government tax breaks will be felt later this year.

Most market economists forecast the Selic will end the year at 8 percent and stay in single digits for most of Rousseff's term in office, which runs through 2014.

Tombini, who helped set up the bank's inflation-targeting regime in 1999, has come under criticism by some who say he is succumbing to pressure from Rousseff to aggressively cut rates even as inflation expectations remain high.

He has denied any political interference and says the evolution of the Brazilian economy has allowed for lower rates.

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