Brazil Tax Cuts May Force Central Bank to Raise Benchmark Rate

Brazil’s central bank may need to raise borrowing costs earlier next year than previously forecast as tax cuts fuel consumer spending and threaten inflation targets.

Finance Minister Guido Mantega approved this week 2.2 billion reais ($1.3 billion) in new and extended tax breaks for vehicles, furniture and construction materials in a bid to boost sales, bolster manufacturing and create jobs.

Adding stimulus to an economy that’s already expanding may quicken inflation, which analysts forecast will hover close to the midpoint of the target of 4.5 percent, plus or minus 2 points. Traders bet the central bank may raise the benchmark interest rate to as high as 12.39 percent by the end of 2010, according to Bloomberg estimates based on futures contracts.

“You are putting more gas onto the fire and that may force the central bank to bring forward the tightening cycle,” Newton de Camargo Rosa, the chief economist at Sul America Investimentos Rosa who helps oversee 11.5 billion reais, said in a telephone interview.

Interest-rate futures jumped yesterday on concern inflation will accelerate and force the benchmark lending rate higher. The yield on the most-traded contract due January 2011 rose five basis points to 10.19 percent, the steepest increase in two weeks, according to data compiled by Bloomberg.

The additional tax cut “overloads monetary policy,” Zeina Latif, chief economist for Brazil at ING Bank, said in a telephone interview from Sao Paulo.

Benchmark Rate

Brazil’s central bank has kept its benchmark lending rate at a record low 8.75 percent at its past two meetings, saying it was “consistent” with a non-inflationary recovery. Policy makers had pushed the rate as high as 13.75 percent last year to battle inflation.

The government is trying to boost growth in an election year by cutting taxes in industries that can help reduce unemployment rates, Francisco Carvalho, head of the currency desk at BGC Liquidez, said in a phone interview.

“The government is doing this because it is sure companies won’t be able to pass price increases on to consumers,” Carvalho said. “It does bring a risk of higher rate increases, but the electoral dispute next year will likely be tough.”

Jose Serra, the governor of Sao Paulo state and a member of Brazil’s biggest opposition party, leads next year’s presidential race, according to polls. Dilma Rousseff, Lula’s chosen candidate to succeed him, trails behind.

To be sure, economists expect consumer prices to rise 4.43 percent in 2010, less than the 4.5 percent target, according to the median estimate in a Nov. 20 central bank survey of about 100 economists.

Stock Market

Brazilian stocks advanced to the highest since June 2008 yesterday on bets sales at steel companies, auto-parts makers and furniture factories will rise because of the tax cuts. The stock index rose 0.9 percent to 67,917.08.

Duratex SA, a maker of bathroom fittings and wood panels, was among the biggest gainers, rising 4.2 percent to 15.2 reais. Eucatex SA Industria e Comercio, which makes materials such as hardboards for the construction industry, rose 1.9 percent to 5.48 reais.

Brazil emerged from its first recession since 2003 in the second quarter as gross domestic product expanded a faster-than- forecast 1.9 percent in the April-June period from the previous quarter. Lula said Brazil may grow at an annualized rate of 9 percent in the third quarter.

“We are stimulating consumption to say: Brazil will have a market,” Mantega told reporters yesterday. “What’s missing in the Brazilian economy today is to stimulate investment.”