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

By Alonso Soto

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

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

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

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

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

"The central bank has to keep hiking rates to mitigate some risks, principally market inflation expectations that are systematically above the center of the target," said Andre Perfeito, chief economist with Gradual Investimentos in Sao Paulo. "Without much help from the government it is up to the central bank to fix the credibility problem."

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

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

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

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

This has prompted investors and analysts to bet that interest rates will keep climbing next year. Most economists expect 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 among major economies, is one of the few countries in the world still boosting borrowing costs. Other emerging-market countries such as Mexico and Poland are slashing interest rates to cope with an international economic slowdown.


HIGH INFLATION

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

Investors are paying close attention to an expected increase in fuel prices this year. State-run oil company Petroleo Brasileiro SA has sustained heavy losses by keeping fuel prices below world market levels to help the government contain inflation.

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

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

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

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

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

Things are not looking brighter for next year.

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

A third year of subpar economic growth, high inflation and weakening government accounts have raised the chance of a credit downgrade next year that could further undermine growth.

Although the government is unlikely to make substantial changes to its fiscal policy, Finance Minister Guido Mantega has promised to contain spending, roll tax cuts and remove some subsidies to improve the administration's accounts.