Brazil Cuts Interest Rate to 11.5% on Slowing Growth, European Debt Crisis

Brazil’s central bank cut borrowing costs by half a point for a second straight meeting, as growth in Latin America’s biggest economy slows amid Europe’s sovereign-debt crisis.

The bank’s board, led by President Alexandre Tombini, voted unanimously to reduce the benchmark Selic rate to 11.5 percent from 12 percent, as forecast by 61 of 68 analysts surveyed by Bloomberg. Five analysts forecast a 0.75-point reduction, and two expected a full-point cut.

The central bank “understands that to mitigate in a timely way effects coming from a more restrictive global environment, a moderate adjustment in the level of the basic rate of interest is consistent with the scenario of the convergence of inflation to the target in 2012,” policy makers said in their statement accompanying their decision.

Policy makers are betting that slowing global demand will offset the stimulus provided by lower borrowing costs and curb the fastest inflation in six years, said Gustavo Rangel, chief Brazil economist for ING Financial Markets. Across Latin America, no other central bank has lowered rates since Colombia did 18 months ago, and in the Group of 20 nations only Turkey has also cut its benchmark rate in response to the global crisis.

“This cycle is basically a gamble,” Rangel, who accurately predicted today’s cut, said by phone from New York before the rate decision. “Countries like Chile and Peru, which would experience a deeper disinflationary impact should the crisis worsen, are still not doing anything.”
External Focus

The central bank raised rates five times this year as near record-low unemployment and a credit boom fueled inflation that in April topped the 6.5 percent upper limit of the bank’s target range. Inflation continued to accelerate even as concerns over a global slowdown led policy makers to reverse course in August; prices in September rose 7.31 percent from a year ago.

Traders expect the bank to cut rates by an additional 1.25 percentage point by April, according to Bloomberg estimates based on interest rate futures yields.

Inflation expectations have jumped since the August rate cut, and economists now expect Brazil to miss its inflation target this year for the first time since 2003, according to an Oct. 14 central bank survey. Economists forecast consumer prices will rise 5.61 percent next year, up from of 5.2 percent at the end of August.
Signs of Cooling

Brazil’s economy is showing signs of cooling. Retail sales in August fell the most since March 2009, while industrial production registered its third fall in five months. Business confidence and the purchasing manufacturer’s index fell to its lowest level since 2009.

The price of iron ore, the country’s biggest export, has fallen 18 percent since the start of September as demand weakened in China.

The economic activity index, a proxy for gross domestic product, shrank 0.53 percent in August, its biggest decline since the global financial crisis of 2008. Analysts expect the economy to grow no more than 3.6 percent this year and next, down from a 7.5 percent pace in 2010 that was the fastest in two decades, according to the most recent central bank survey.

Even so, the labor market has yet to react to the slowdown. Unemployment fell to 6 percent in August, a record low for the month, down from 6.7 percent a year earlier. The country generated about 209,000 registered jobs last month, higher than the 169,000 forecast in a Bloomberg survey, and up from 190,000 in August.
Labor Demand

Full-employment conditions and the fastest inflation since 2005 have provoked accelerating wage demands. This month, bank and postal workers went on strike for pay increases in excess of inflation.

Loan growth has also yet to show signs of slowing. The central bank last month raised its forecast for credit expansion this year to 17 percent, from Tombini’s preferred 15 percent rate. Total outstanding loans rose 19.4 percent in the year through August.

The yield on the interest rate futures contract maturing in January 2012, the most traded in Sao Paulo today, fell two basis points to 11.12 percent.

The benchmark Bovespa stock index has declined 18 percent in dollar terms since the end of July, more than the MSCI Emerging Markets Index. The real has weakened 13 percent since the start of August, the second-most of seven major Latin American currencies tracked by Bloomberg after Mexico’s peso.