Brazil Credit Curbs, Rate Increase to Fight Inflation

Brazil’s central bank raised its benchmark interest rate yesterday for the first time since July, and signaled it will also rely on administrative steps to curb the growth of credit to fight the fastest inflation in two years.

Policy makers led by Alexandre Tombini, chairing his first meeting as bank chief, voted unanimously yesterday to raise the Selic rate by 50 basis points to 11.25 percent, matching the forecast of 49 of 51 analysts in a Bloomberg survey. The bank, in a one-sentence statement, said it was beginning a “process of adjustment” in rates that along with “macro prudential” measures will slow inflation to its 4.5 percent target.

“The central bank faces limitations in using interest rates only,” Marcelo Salomon, chief economist for Brazil at Barclays Plc in New York, said in a phone interview. “It doesn’t plan to just use rate increases against inflation given the global uncertainties and the government’s need to contain the appreciation of the real.”

Inflation expectations have increased since the central bank published its quarterly inflation report Dec. 22, leading traders to bet Tombini may lift the Selic to as high as 13.25 percent this year. The statement reinforces Barclays’ call that policy makers are concerned about currency gains, which took the real to a 28-month high Jan. 3, and plan to raise rates no further than 12.25 percent this year, Salomon said.

‘Dovish’

Tombini may step up credit measures such as raising reserve and capital requirements for local banks in an effort to contain price increases in Latin America’s biggest economy, Salomon said.

Traders are likely to pare bets on interest rate increases this year, said Virgilio Castro Cunha, head of economics and fixed-income strategy at Bank of America Corp. in Sao Paulo.

“The statement should be interpreted as dovish by markets as the board seems to be framing the interest rate cycle in a broader scheme to bring down inflation,” Cunha wrote in an e- mail interview.

The central bank raised reserve and capital requirements in December to slow consumer lending growth, removing at least 61 billion reais ($36.5 billion) from circulation. The bank estimates the move was equivalent to lifting the benchmark rate by 0.5 percentage point to a full point, said a person familiar with the bank’s decision-making process.

‘Too Shy’

Consumer prices in the $1.57 trillion economy rose more than economists expected in December, pushing the year-end inflation rate up to 5.91 percent, the fastest pace for a calendar year since the 7.6 percent jump posted in 2004.

Inflation will remain “around” the 4.5 percent target in the next two years if policy makers increase borrowing costs 150 basis points, or 1.5 percentage point, to 12.25 percent in 2011 and the real remains stable, Carlos Hamilton, central bank director for economic policy, said after the inflation report was published.

“We continue to believe that the consensus call, pushing the Selic rate to 12.25 percent, seems too shy to cope with the current and expected inflationary pressure,” Alexandre Schwartsman, chief economist at Banco Santander in Sao Paulo, wrote yesterday in an e-mailed report.

The bank will need to raise borrowing costs to 13 percent by the middle of the year, to meet its inflation target, Schwartsman said.

After the bank’s decision, Goldman Sachs Group Inc. economists Paulo Leme, Alberto Ramos and Luis Cezario said in a e-mailed research note that they maintained their view for a 250 basis-point “tightening cycle” to take the Selic to 13.25 percent.

Expectations, Currency War

Barclays forecasts inflation will quicken to 6.3 percent this year, as the central bank limits rate increases to 150 basis points.

Inflation expectations for 2011 rose for a sixth straight week, according to a Jan. 14 central bank survey of about 100 economists. Consumer prices will rise 5.42 percent this year, up from a week earlier forecast of 5.34 percent, the survey found.

Since President Dilma Rousseff took office Jan. 1, Brazil has tried three different tactics to try to curb a rally in the real, which has strengthened 38 percent against the U.S. dollar since the start of 2009, the most of 25 emerging market currencies tracked by Bloomberg.

On Jan. 6, the central bank announced a reserve requirement on short dollar positions in a bid to reduce bets against the dollar.

On Jan. 10, the government authorized its sovereign wealth fund to buy dollars in the derivatives markets, and on Jan. 14 the central bank auctioned reverse swaps worth $1 billion, to try to weaken the real.

Tombini said Jan. 6 that the reserve measures on dollar positions are unrelated to monetary policy.

The currency has strengthened as near-zero interest rates in the U.S., the European Union and Japan led investors to seek higher yielding assets in emerging markets.

Brazil has the highest real, or inflation-adjusted, interest rate in the Group of 20 Nations.

Finance Minister Guido Mantega said Brazil is a victim of a “currency war” in which nations are trying competitively to devalue their currencies.