Brazil to reverse easing as inflation fears rise

Brazil’s central bank has begun reversing some of the monetary easing enacted in response to the global crisis, in a sign of concern over inflation.

The bank will withdraw about R$71bn (US$39.5bn, €29bn, £25.4bn) from circulation between March and June by partially reversing a reduction in reserve requirements – the share of their deposits that banks must park at the central bank – that released about R$100bn into the money supply following the onset of the crisis in September 2008.

“The bank has sent a signal that it is concerned about inflation,” said Ilan Goldfajn, chief economist at Itaú Unibanco in São Paulo. “We think it will start raising interest rates in March and [complete a tightening cycle] pretty quickly, probably by July.”

In response to the crisis, the central bank cut its target overnight interest rate, known as the Selic, from a peak of 13.75 per cent at the end of 2008 to 8.75 per cent in July last year and has kept it unchanged since. But as Brazil’s economy emerged from a deep but short recession in the second half of last year, inflationary pressures have returned.

The economy is expected to grow by at least 5.5 per cent this year, which many economists think is fast enough to fuel inflation.

The government’s target for annual consumer price inflation is 4.5 per cent; during the past month the market consensus forecast for 2010 has risen from 4.6 per cent to almost 4.9 per cent.

“If you look at inflation expectations and other measures of activity like unemployment and capacity utilisation, it’s hard to avoid the conclusion that the economy is operating with very little slack and that inflationary pressures are building,” said Marcelo Carvalho, chief economist for Brazil at Morgan Stanley in São Paulo.

This will almost certainly leave the central bank with the politically difficult task of raising interest rates during the approach to Brazil’s presidential, congressional and gubernatorial elections in October.

Some economists argue that by tightening reserve requirements, the central bank has postponed the need to raise interest rates. Others say the move reinforces perceptions that it is worried and could therefore move more quickly. Either way, most expect the Selic rate to rise to 11.25 per cent by the third quarter.

The central bank’s job is complicated by inflation pressure resulting from other measures taken in response to the crisis. While monetary measures are easily undone, fiscal measures taken since late 2008 will be harder to reverse.