Brazil Rate Cut to Prevent Slowdown in Inflation, Macquarie’s Welch Says

Brazil’s interest-rate reduction last week will prop up domestic demand and prevent inflation from slowing from a six-year high, said John Welch, chief emerging-markets strategist at Macquarie Capital Inc.

Welch, speaking at the Bloomberg Global Inflation Conference in New York, said the 50 basis-point rate cut to 12 percent on Aug. 31 shows Brazilian policy makers are “betting” inflation will slow before year-end. Annual inflation surged last month to 7.2 percent, the fastest rate since 2005, in Latin America’s biggest economy.

“I don’t see any reason for inflation dropping,” Welch said. “At the margin, it’s accelerating again.”

Brazil’s rate cut, which followed five consecutive increases, surprised all 62 analysts surveyed by Bloomberg, who expected rates to be left unchanged. The central bank signaled it may reduce borrowing costs further on expectations the global economic slowdown will help inflation slow in line with its 4.5 percent target next year, according to the minutes of the meeting released today.

“They will rethink it,” said Welch, the former chief Latin America economist at Lehman Brothers Holding Inc.

A rebound in the U.S. dollar would curb the increase in global commodities, helping slow inflation in Brazil and support the central bank’s rate move, Steve Hanke, a professor of applied economics Johns Hopkins University, told the conference.
‘Winning Bet’

Most of the swings in emerging-market inflation are being driven by the “weak” dollar as the Federal Reserve prints money to spur growth, said Adam Lerrick, an economics professor at Carnegie Mellon University in Pittsburgh.

“If there’s a flight back into the dollar, maybe what they are doing is a winning bet,” Hanke said.

Interest-rate futures contracts indicate that traders are anticipating the central bank will lower borrowing costs another 100 basis points in its final two policy meetings this year, according to data compiled by Bloomberg.

While industrial production fell in July, the labor market remains tight with the unemployment rate declining to a seven- month low of 6 percent in July. Bank lending expanded at a 20 percent annual pace while the minimum wage is set to increase 14 percent next year, according to a government formula.

A gauge of investors’ inflation expectations, known as the breakeven rate, soared to a five-month high after the rate cut. The yield gap between inflation-linked bonds and interest-rate futures due in 2013 jumped to 6.21 percentage points on Sept. 2, the highest level since April, according to data compiled by Bloomberg. The breakeven rate was 6.18 percent today.