Brazil Raises Key Interest Rate

Faced with rising inflation and robust consumer demand, the Central Bank of Brazil raised its Selic base interest rate half a percentage point Wednesday, a move widely anticipated by financial market participants.

The meeting was the first under newly appointed Central Bank President Alexandre Tombini, who assumed the office Jan. 1. Mr. Tombini replaced his mentor, Henrique Meirelles, who had served in the job for eight years, longer than anyone else since the creation of the central bank in 1964.

The rate increase, sure to be unpopular with consumers and businesses, was a test of Mr. Tombini’s independence. WestLB Bank’s top Brazil strategist Roberto Padovani wrote earlier this week, “A rate hike will serve as a sign that the central bank has renewed its commitment to inflation targeting.”

The bank’s monetary policy committee raised the Selic rate to 11.25% from the previous 10.75%.

But, in a statement following the meeting, the committee warned that Wednesday’s increase was likely to mark the beginning of a new cycle of monetary tightening, mirroring similar moves among other emerging markets combating intensifying inflation pressures amid solid economic growth.

In an unusually brief statement, the committee said it was ordering the rate increase “as the start of a process of adjustment to the base interest rate.” The statement said the central bank will continue to monitor inflation in the light of both monetary tightening and other governmental actions, such as planned budget cuts by the federal government.

The central bank said the committee vote was unanimous.

Under Brazil’s inflation-targeting program, instituted in 1999, the central bank is obliged to act whenever inflation threatens to jump higher than the target range. Such action can include alterations in reserve requirements for banks, as well as other measures, but is usually grounded in interest rate hikes.

Inflation has been a major worry in recent months.

Brazil ended 2010 with calendar year inflation of 5.91%, up sharply from 4.31% in 2009. The 2010 rate was also much higher than the annual target for the year of 4.5%.

Brazil’s inflation target for 2011 is once again 4.5%, meaning the central bank has its work cut out for it.

Although much of the impetus behind the recent surge in inflation has come from soaring food prices, considered a temporary factor by many economists, at least some of the pressure is coming from surging consumer demand.

Brazilian retail sales in November rose 1.1% from the previous month and a startling 9.9% from November of 2009. December figures are likely to be even more robust, according to economists.

Because of such worries, Wednesday’s rate increase may not be the last.

In this week’s central bank survey of financial market opinion, published Monday, economists predicted a rise in the Selic rate to 12.25% by the end of the year. Even with a raft of rate hikes, the same analysts predicted a year-end inflation rate of 5.42%, down only marginally from 2010.

But interest-rate hikes can be a double-edged sword, hurting not only growth and investment but also exports.

Higher interest rates also typically bring in more short-term foreign investment to Brazil’s lively fixed-income market. Heavy investments in recent years have led to a sharp appreciation of the Brazilian real against the U.S. dollar.

The real has gained more than 30% against the dollar since early 2009, hurting Brazilian exports. The strong real also undermines manufacturers in the domestic market because of stiff competition from ever cheaper imported products.