Brazil’s Inflation Risk Grows

Brazil’s economic recovery is likely to be even stronger next year than first thought, bringing a renewed risk of inflation.

In its fourth-quarter inflation report, released Tuesday, the Central Bank of Brazil said growth could swell to 5.8% in 2010 from near zero this year. Most economists are forecasting 2010 growth of about 5%.

But the report also forecast a rise in the inflation rate, from 4.3% projected this year to 4.6% in 2010 and 2011. The bank’s inflation goal for each of the three years is 4.5%.

Economists said the risk of inflation and interest-rate increases can no longer be ignored.

“Although there is a seemingly benign inflation outlook, there is always a risk when inflation goes above target,” said Flavio Serrano, an economist at the BES Investimento fund in São Paulo. “Because of this, we’re expecting an increase in interest rates next year.”

Brazil’s Selic base rate is currently 8.75%. This week’s central-bank survey of private economists, released Monday, predicted a rise to 10.75% by the end of 2010.

Brazilian financial markets reacted positively to Tuesday’s central-bank report, with Brazil’s benchmark Ibovespa stock index rising 2.3% to close at 67417. But domestic interest-rate futures contracts ticked up, with the January 2011 contract moving to 10.36% from 10.33% at Monday’s close.

Central-bank officials, meanwhile, appeared to confirm the market’s suspicions about rising inflation risk, communicating what analysts interpreted as a somewhat hawkish tone.

Speaking after the release of the inflation report Tuesday, the bank’s chief economist, Mario Mesquita, said Brazil’s economy has a higher-than-average risk of inflation due to historic factors such as price and contract indexing.

“Brazilian inflation shows a persistence above the average seen in other countries,” said Mr. Mesquita. “Because of this, authorities always need to remember that seeking prevention for it is better than seeking a treatment afterwards.”

The tough talk came as other data reported Tuesday reflected improving economic activity. Brazilian federal tax receipts rose 26% in November to their highest level this year and consumer confidence measured by the Getulio Vargas Foundation hovered near records, at 111 points. Figures above 100 indicate positive sentiment.

Meanwhile, one risk highlighted by the central bank in its report Tuesday is the danger that Brazilian industry might prove unable to meet the heavy demand brought about by the country’s rapid return to growth.

“The remaining margin of idle capacity may be occupied more swiftly than contemplated under the main scenario, which is based on a gradual recovery of the economy,” the report said. “In other words, there’s a risk that supply conditions won’t fully respond to a case of more accentuated demand.”

That case appears to be increasingly likely. As of October, Brazil was already using 80.5% of its installed industrial capacity, up from around 78% earlier this year and toward the 82% level seen before the global economic crisis hit Brazil in 2008.

The latest signals from the central bank seem to leave only one question: when, not if, the monetary authority will begin raising its base rate.
—Rogerio Jelmayer in São Paulo contributed to this article.