Brazil Signals More Rate Increases to Come After Raising Selic to 12.25%

Brazil’s central bank raised the benchmark lending rate for a fourth straight time and signaled it is prepared to increase borrowing costs further, bucking economists’ projections.

Policy makers kept a pledge to raise borrowing costs for a “sufficiently long period” to bring inflation back to target in 2012, in a statement accompanying yesterday’s decision to boost the Selic a quarter-point to 12.25 percent. Analysts had expected the rate to reach 12.50 percent in July and remain there until year-end, a June 3 central bank survey said.

The wording shows bank President Alexandre Tombini plans to raise the Selic more than a quarter-point to cool inflation that in April breached the 6.5 percent upper limit of the bank’s target range for the first time since 2005, said Marcelo Salomon, chief economist for Brazil at Barclays Plc. Brazil’s rate rises have helped stoke a 17 percent climb in the real against the dollar in the past year.

“There’s more to come,” Salomon said in a phone interview from New York. “If they’d wanted to signal that this was the last one, or that they are close to the last one, they would have changed the phrase.”

With unemployment near a record low, and credit expanding at a 20 percent annual pace, inflationary risks in Latin America’s biggest economy remain high. Yesterday’s decision, part of what the bank called a “gradual” adjustment of monetary conditions, matched the forecast of 51 of 52 analysts surveyed by Bloomberg.
Trader Expectations

Most interest rate futures contracts maturing between July 2011 and October 2012 rose, as traders increased bets the central bank will continue to raise rates.

The yield on the interest rate futures contract maturing in January 2012, the most traded on the Sao Paulo exchange, rose one basis point, or 0.01 percentage point, to 12.40 percent at 8:53 a.m. New York time.

The real fell 0.3 percent to 1.5865 per U.S. dollar. The currency has gained 4.7 percent against the dollar in the last three months, the second-best performance among seven Latin American currencies tracked by Bloomberg, after the Colombian peso.

Nationwide, workers are demanding bigger wage increases. Firemen in Rio de Janeiro, assembly line workers for Volkswagen AG in Parana state and transportation workers in Brasilia are all currently on strike, demanding raises above inflation.
‘Price Stability’

In its most recent quarterly inflation report, the central bank said moderation in wage increases is “a key element for obtaining a macroeconomic environment with price stability.”

“There is a lot of anecdotal evidence that shows employees empowered to demand higher wages, especially in construction,” said Gustavo Rangel, chief Brazil economist for ING Financial Markets in New York. “That’s the biggest risk.”

Rangel, before yesterday’s decision, said that he expects two further quarter-point rate increases this year.

Economists covering Brazil’s economy lowered their year-end inflation forecast to 6.22 percent, according to the median estimate in a weekly central bank survey published June 6, down from an estimate of 6.37 percent at the end of April.

Monthly inflation slowed to 0.47 percent in May, from 0.77 percent in April, as fuel prices slumped and a stronger currency cut costs for imported consumer goods. The central bank targets inflation of 4.5 percent, plus or minus two percentage points.
Budget Cut

President Dilma Rousseff’s government earlier this year cut 50.7 billion reais ($32 billion) from its 2011 budget, while in December the central bank raised banks’ reserve requirements. In April, Finance Minister Guido Mantega doubled to 3 percent the so-called IOF tax on consumer credit.

Brazil’s economy gained speed in the first quarter. Gross domestic product expanded 1.3 percent from the previous three- month period. In the fourth quarter of 2010, GDP grew 0.8 percent.

Tombini told lawmakers March 22 that growth in consumer credit of more than 15 percent needs to be monitored “very carefully.” Total outstanding credit rose 21 percent from a year earlier in April

Even though domestic demand remains heated, Brazil’s inflation fight may be helped by a continued slowdown in the global economy, said Flavio Serrano, chief economist at Espirito Santo Investment Bank.

“Leaving analysts in doubt about the duration of the tightening cycle is very positive,” Zeina Latif, a Latin America strategist at RBS Securities Inc., said in a phone interview from Sao Paulo. “It reinforces the bank’s credibility by signaling they will not stop ahead of time because of short term data.”