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Brazil may end tightening after raising rates to two-year high

A man walks out of the headquarters of the central bank in Brasilia January 15, 2014. REUTERS/Ueslei Marcelino
A man walks out of the headquarters of the central bank in Brasilia January 15, 2014. REUTERS/Ueslei Marcelino

By Alonso Soto

BRASILIA (Reuters) - Brazil raised interest rates to a two-year high on Wednesday, but signaled that it is ready to halt its aggressive monetary tightening if a surge in inflation subsides in coming weeks.

The central bank's monetary policy committee unanimously raised its benchmark Selic rate by 25 basis points to 11 percent, its ninth straight rate increase in a year. All of the 62 analysts surveyed by Reuters had predicted the increase.

The bank changed the language used in its decision statement to say that its next monetary move would hinge on how the Brazilian economy as a whole evolved.

"The committee will monitor the evolution of the macroeconomic outlook until its next meeting, to then define the next steps in its monetary policy strategy," the bank said.

In the statement, the bank removed a previous reference to continuation of the adjustment cycle and instead added that it decided to raise the rate at "at this moment."

Although another rate rise in May has not been ruled out, the statement signaled that the bank would be very sensitive to forthcoming economic and inflation indicators to decide whether to continue raising borrowing costs or halt the cycle.

Many analysts have said the bank could very well pause the tightening cycle in May to avoid hampering the growth of an economy that has been stuck in a rut for the last three years.

"The central bank has gone into data-watching mode, which signals that the tightening cycle has either ended or is nearing its end," said Robert Wood, Brazil analyst for the Economist Intelligence Unit.

"Unless there is moderation in wholesale food prices before the next meeting, I think the bank will likely hike by another 25 bps."

A spike in food prices due to a severe drought in southern Brazil has rekindled fears of high inflation as President Dilma Rousseff gears up to run for re-election in October.

The central bank will have to find the right balance that allows it to ease inflation and avoid further slowing growth, both areas that dented Rousseff's popularity in a recent poll.

It is not an easy task for a bank that has struggled to lower expectations of high inflation despite a staggering 375 basis point rise in the benchmark interest rate since April 2013.

INFLATION JITTERS

Some market traders are speculating that the bank may allow the local currency, the real, to strengthen further as a way to contain price pressures. A stronger real, which has gained about 4 percent against the dollar so far this year, lowers the prices of imports.

The surge in food prices has overshadowed a moderate pick-up in activity at the start of the year, which briefly raised hopes the Brazilian economy may grow more than 2 percent this year.

A more rapid increase in food prices could hit domestic consumption, which has been the country's main engine of growth as investment has remained subdued in recent years.

Other price pressures could come from an increase in the prices of fuel and electricity, which the government is trying to contain, but economists believe will have to rise either this year or next.

The mix of low economic growth and high inflation was one reason behind Standard & Poor's decision to cut Brazil's rating closer to junk territory last week.

Inflation expectations for 2014 have risen to 6.30 percent last week from 5.86 percent in early February, according to a weekly central bank poll of economists.

(Additional reporting by Silvio Cascione and Asher Levine; Editing by Anthony Boadle and Mohammad Zargham)

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