Brazil's government sees higher rates sinking recovery -sources

BRASILIA, Jan 14 (Reuters) - Brazilian President Dilma Rousseff’s left-leaning administration is worried a possible interest rate hike next week will foil its efforts to revive a battered economy while failing to curb inflation, government sources said on Thursday.

The ruling Workers Party, unions and businesses are pressuring the central bank to keep its Selic rate unchanged to avoid deepening what is on track to become Brazil’s worst recession in more than a century.

The central bank has raised the rate by 700 basis points since 2013 to 14.25 percent - the highest benchmark interest rate of any major economy - but has had scant success in stemming price rises. Annual inflation surged to a 12-year high of 10.67 percent in December, more than double the official target of 4.5 percent.

Inflation expectations for this year and next continue to rise as Brazil’s currency, the real, weakens and major cities raise bus fares.

Most economists expect the central bank to raise the rate by 50 basis points on Wednesday, though they are concerned such a move will place it in conflict with the government’s more expansionist fiscal stance. The administration is almost certain the central bank will raise rates next week despite some recent doubts among market traders, two government sources said.

The government’s plan to increase credit for some sectors of the economy and to help the auto industry and small businesses show a growing disconnect with the central bank, they say.

Although Rousseff’s government will not interfere, the two officials said a rate hike was unnecessary as the deepening recession, which has cost 1.5 million Brazilians their jobs over the past year, would eventually cool inflation.

“Our concern is that higher rates will again fail to bring down inflation while further sinking the economy,” a presidential aide familiar with the matter said on condition of anonymity.

“We don’t doubt the bank will raise rates again, but we may not need this tough medicine right now.”

Tensions between the government and the central bank flared during Rousseff’s first term between 2011 and 2014 when public spending boomed, but eased as the president reined in expenditures last year.

Rousseff has insisted she will maintain the austerity drive championed by former finance minister Joaquim Levy, a fiscal hawk who quit in December amid policy disagreements.

However, signs that Rousseff is quietly easing public spending cuts to appease her allies in Congress before it votes whether to impeach her could blunt monetary policy, many analysts argue.

Finance Minister Nelson Barbosa supports a more gradual fiscal adjustment and is in talks with state-run banks to open new credit lines.

“If those measures materialize it will not only reduce the efficiency of monetary policy, but also mark a return of policy contradictions,” said Alessandra Ribeiro, a partner with Sao Paulo-based economic consultancy Tendencias.

Rousseff’s office and the central bank declined to comment. Rousseff and Barbosa have publicly emphasized the central bank’s operational autonomy.

The central bank has clearly signaled that another round of rate hikes is almost inevitable to make good on its promise to bring inflation down to its target in 2017.

Two of its eight board members voted for a hike of 50 basis points at the Nov. 25 meeting, in a strong indication of a policy shift.

Central bank chief Alexandre Tombini said in a letter last week that “regardless of other policies the central bank will take the necessary measures to meet its inflation-targeting objectives.”

Baulking at a rate hike next week could tarnish the bank’s credentials and lead to market volatility, analysts say.

“The central bank has put itself in this position by clearly signaling a rate hike,” said Juan Jensen, partner with 4E consultancy. “If it does not raise rates now it will leave the impression of political intervention.”

$1 = 3.9996 Brazilian reais Editing by Daniel Flynn and Paul Simao