Brazil May Raise Rate to 11% to Slow Growth, Head Off Inflation

Brazil’s central bank will probably maintain its “aggressive” pace of interest rate increases and raise borrowing costs for a third straight meeting today to slow growth to a level that won’t stoke a resurgence of inflation.

Policy makers will raise the Selic benchmark rate 75 basis points to 11 percent from 10.25 percent, according to 45 of 48 economists surveyed by Bloomberg. Three analysts expect a half- point increase, in line with traders’ bets after a report yesterday showed that prices unexpectedly fell in the month through mid-July.

While traders seized on the first bout of deflation in four years to push yields on interest rate-futures down for a sixth day, economists such as Barclays Capital Inc.’s Marcelo Salomon say the bank can’t afford to slow the pace. Inflation has been above the bank’s 4.5 percent target all year and more action is needed to cool the fastest economic growth in 15 years, he said.

“It may seem aggressive if you look at the international context, but given Brazil’s economic growth it isn’t,” Salomon, chief Brazil economist at Barclays’ in New York, said in a phone interview. “The speed of economic expansion was much higher than expected.”

Policy makers will announce the interest rate decision after 5 p.m. New York time today.

Latin America’s biggest economy will expand 7.2 percent this year, the fastest pace in more than two decades, and inflation will exceed the government’s goal this year and next, according to the median forecast in a central bank survey of about 100 economists published this week.

Growth-Inflation Dynamic

Economists predict inflation will quicken to 5.42 percent by December before slowing to 4.8 percent next year, the central bank survey shows. Prices fell 0.09 percent through mid-July, while the annual rate as measured by the IPCA-15 index slowed to 4.74 percent, the statistics agency said yesterday.

“The central bank needs to remain alert to prevent demand from stoking prices — that’s why it must keep the 75 basis- point increase” said Newton Rosa, who helps manage 16 billion reais ($9 billion) as chief economist at Sao Paulo-based SulAmerica Investmentos. “Consumption will remain strong in coming months and will keep pushing economic activity.”

Central bank chief Henrique Meirelles needs to continue the current pace of monetary policy adjustments to ensure economic expansion slows to 4.5 percent, a level compatible with the bank’s target, Barclays’ Salomon said.

Calibrating Growth, Forecasts

To be sure, Brazil’s $1.6 trillion economy is showing signs of cooling from an annual growth rate of 9 percent in the first quarter, after job creation and tax collection in June trailed economists’ forecast.

Brazil created 212,952 government-registered jobs in June, down from 298,041 in May, according to the Labor Ministry. Industrial output and retail sales expanded in May less than analysts forecast.

Yields on interest-rate future markets tumbled after Brazil’s statistics agency said yesterday that consumer prices fell through mid-July. Traders are pricing in a 0.58 percentage point increase today, according to Bloomberg estimates based on interest-rate futures contracts.

The yield on contracts due January 2011, the most traded on the BM&F Bovespa exchange, fell 34 basis points, or 0.34 percentage point, since July 1 to 10.97 percent yesterday.

Recent economic figures led Itau Unibanco Holding SA to lower its year-end forecasts for Brazil’s benchmark lending rate to 11.5 from 11.75 percent, Brazil’s largest bank by market value said in an e-mailed statement July 16.

Policy Options

The pace of Brazil’s economic expansion will ease in the third quarter after the government withdrew tax cuts and other stimulus, Finance Minister Guido Mantega said July 15.

The central bank’s seasonally adjusted economic activity index fell to 139.55 points in May from 139.58 points in April, also signaling slower growth.

Slower global expansion may help reduce commodity prices and inflationary pressures in Brazil, SulAmerica’s Rosa said.

Still, the Brazilian economy is growing above its potential, Bertrand Delgado, senior analyst for emerging markets at Roubini Global Economics, said in a note to clients this week.

He estimates there is a 30 percent chance policy makers opt for increasing the Selic by less than 75 basis points today.

“A smaller increase right now gives the central bank time to assess economic figures without the pollution of volatility caused by the financial crisis,” said Marina Santos, an economist at Squanto Investimentos Ltda, one of the three economists expecting a 50 basis point increase today.