Brazil likely to raise base interest rate, end single-digit era

Reuters

By Alonso Soto

BRASILIA, Nov 27 (Reuters) - Brazil will likely raiseinterest rates for the sixth consecutive time on Wednesday,taking borrowing costs back to double digits as policymakersrace to contain naggingly high inflation in Latin America'slargest economy.

An overwhelming majority of analysts polled by Reuters lastweek expect the central bank to hike its benchmark Selic rate a half a percentage point to 10 percent -- thehighest since March 2012.

The return to double digits is considered a politicalsetback for President Dilma Rousseff, who made lower rates a keyeconomic goal of her government. The Selic stood at 10.75percent when she took office in 2011.

After raising rates early in her term, the central bankaggressively slashed the Selic to a record low 7.25 percent inOctober 2012. The government had hoped the cuts would usher in anew era of cheap credit and sustained economic growth.

However, lower rates failed to speed up the economy, whichwas held back by another historical drag on Brazilian growth -high inflation. Inflation forced the central bank to changecourse, raising the benchmark rate by 2.25 percentage pointssince April in a bid to bring annual inflation back to the 4.5percent center of its target range.

"The central bank has to keep hiking rates to mitigate somerisks, principally market inflation expectations that aresystematically above the center of the target," said AndrePerfeito, chief economist with Gradual Investimentos in SaoPaulo. "Without much help from the government it is up to thecentral bank to fix the credibility problem."

He expects the bank to increase rates to 11 percent nextyear to control prices and reduce inflation expectations. Thebank is supposed to set rates in a way that keeps consumer priceinflation close to a 4.5 percent-a-year target plus or minus 2percentage points.

The central bank has raised rates much more than expectedthis year, regaining some of its credibility as an inflationfighter even as the inflation rate remains above the center ofthe target range.

At the same time, the central government is struggling toconvince markets it is ready to control spending in order toavoid a sovereign downgrade next year.

The erosion of government accounts comes as spending growsfaster than revenue. Service-industry costs are also rising andgovernment-controlled prices such as bus fares and fuel pricesare expected to increase.

This has prompted investors and analysts to bet thatinterest rates will keep climbing next year. Most economistsexpect Brazil to raise rates to 10.50 percent next year,according to the latest weekly central bank survey.

Brazil, which already has the highest interest rates amongmajor economies, is one of the few countries in the world stillboosting borrowing costs. Other emerging-market countries suchas Mexico and Poland are slashing interest rates to cope with aninternational economic slowdown.

HIGH INFLATION

Annual inflation climbed less than expected in mid-November,but remains well above the center of the target and is underpressure from rising food prices. The IPCA-15 consumer priceindex rose 5.78 percent in the 12 months tomid-November.

Investors are paying close attention to an expected increasein fuel prices this year. State-run oil company PetroleoBrasileiro SA has sustained heavy losses by keepingfuel prices below world market levels to help the governmentcontain inflation.

Those losses though are making it harder for Petrobras, asthe oil company is known, to pay for massive offshore oilinvestments the government hopes will generate a tax windfallfor schools and health care.

The central bank has signaled it does not intend to slow thepace of rate hikes, repeating in recent weeks its view thatmonetary policy needs to remain vigilant to battle inflation.

High inflation is blamed for the weak performance of theBrazilian economy, which has also struggled in the last threeyears because of supply bottlenecks spurred by high taxes,burdensome red tape and a crumbling infrastructure.

The Brazilian economy may have actually contracted slightlyin the third quarter from the previous quarter, some economistspredict, evidence of the erratic pace of an economy that isexpected to grow 2.5 percent this year. The economy grew 7.5percent in 2010, its most in a quarter century.

Another immediate risk to the economy lays in the hands ofthe Supreme Court, which on Wednesday begins reviewing acontroversial savings accounts case that could cost banks morethan 100 billion reais ($44 billion) and contract credit.

Things are not looking brighter for next year.

Higher interest rates and an expected withdraw of monetarystimulus in the United States could further slow the Brazilianeconomy in 2014, when Rousseff is expected to run for anotherfour-year term. Economists see the economy growing only 2.1percent in 2014.

A third year of subpar economic growth, high inflation andweakening government accounts have raised the chance of a creditdowngrade next year that could further undermine growth.

Although the government is unlikely to make substantialchanges to its fiscal policy, Finance Minister Guido Mantega haspromised to contain spending, roll tax cuts and remove somesubsidies to improve the administration's accounts.

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