Brazil Says Fifth Rate Increase Not Enough to Hit CPI Target in 2012

Brazil’s central bank signaled that a fifth interest rate increase this year won’t be enough to slow inflation to its target in 2012. Interest rate futures yields rose.

The bank, in its quarterly inflation report today, forecast consumer prices will rise 4.9 percent in 2012 and slow to the 4.5 percent target in the second quarter of 2013, if it increases the benchmark interest rate to 12.50 percent in July and the real weakens. Prices will rise 5.8 percent this year, under the so-called market scenario.

The central bank reiterated that it will raise interest rates for a “sufficiently long” period, after increasing its inflation forecasts from its March report. The 11 most traded interest rate futures contracts in Sao Paulo rose this morning, as traders increased bets that policy makers will raise rates at their next two meetings.

“I was surprised by the inflation projections that worsened more than was expected,” said Flavio Serrano, chief economist at Espirito Santo Investment Bank. “This increases the probability of a rate hike of 25 basis points for August after an increase in July.”

The yield on interest rate futures maturing in January 2012, the most-traded in Sao Paulo, rose two basis points to 12.43 percent at 9:20 a.m. New York time. The real fell 0.1 percent to 1.5767 per U.S. dollar.
August Decision

Traders expect the central bank to increase the Selic a quarter point to 12.50 percent at its July 20 meeting, and are split on whether policy makers will raise again in August, according to Bloomberg estimates based on interest rate futures.

The central bank misses its 2012 target in all of its three inflation outlooks — the reference, the market and the alternative scenarios. All three outlooks show consumer prices only meeting the target in the second quarter of 2013.

While inflation is slowing in Latin America’s biggest economy, a tight labor market may boost price pressures.

Wholesale, construction and consumer prices, as measured by the IGP-M price index, fell in June for the first time since December 2009 as agricultural prices tumbled, the Getulio Vargas Foundation said in a report today. The 0.18 percent decline compared with a 0.43 percent rise in May and the median estimate for a 0.2 percent drop in a Bloomberg survey of 28 analysts.

The index rose 8.65 percent from a year ago. Agricultural prices sank 1.8 percent from the previous month.
Consumer Prices

Consumer prices, as measured by the IPCA-15 index, rose 0.23 percent in the month through mid-June, the slowest pace since August and down from 0.70 percent a month earlier. Still, low readings a year ago led to an acceleration in the annual inflation rate to 6.55 percent, the fastest since July 2005.

The widespread use of “indexation,” or linking prices and salaries to past inflation, increases the so-called sacrifice ratio, or the amount of gross domestic product lost in order to cool price pressures, the report said.

The central bank slowed the pace of tightening to a quarter point in April, after half-point increases at its two previous meetings.

The bank said today it expects the pace of loan growth to slow in the coming months, though a tight labor market and wage increases remains a “very important” inflation risk. Credit expanded in May at the fastest pace this year, and unemployment fell to the lowest on record for the month of May.

The central bank expects economic growth to slow to 4 percent this year from a two-decade-high of 7.5 percent in 2010, the inflation report shows. That was unchanged from its previous forecast in the March quarterly report.

President Dilma Rousseff is relying on higher borrowing costs, measures to curb consumer credit and spending cuts to slow inflation that has remained above the 6.5 percent upper limit of the target range since April. The bank today reiterated that a prolonged tightening cycle remains the “most adequate” strategy.