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Brazil Hikes Rates, Even as Global Peers Cut

Chad Ehlers | Photographer's Choice | Getty Images

Brazil's central bank raised its benchmark interest rate on Wednesday to 8 percent from 7.5 percent, stepping up the pace of a tightening cycle to battle high inflation as Latin America's largest economy struggles with slow growth.

The bank's monetary policy committee, known as Copom, voted unanimously to hike its Selic rate by 50 basis points. The decision followed disappointing first quarter growth that prompted markets to price in a milder 25-basis-point increase.

In a short statement, the bank said the "decision will contribute to lowering inflation and ensuring that the trend continues next year."

The bank removed previous references to "caution" in future decisions, indicating that policymakers could continue to deliver aggressive rate hikes to stem a surge in prices.

The steeper hike could help the central bank and its chief Alexandre Tombini regain some of its lost credibility to fight inflation and ease high inflation expectations that some fear could halt much-needed investment and erode consumption.

"Excellent, we welcome the move. It helps the central bank regain its credibility and anchor inflation expectations," said Alberto Ramos, economist with Goldman Sachs in New York. "Well done all across. Consistent message and unanimous decision."

Brazil is one of the few major world economies currently raising interest rates as strong demand, high production costs and infrastructure bottlenecks keep inflation closer to the upper end of an already high official target range.

Tombini had signaled he may step up the tightening cycle, dropping previous references to "cautious" rate hikes and instead adopting more incisive language, saying the central bank will "do what is necessary, in a timely manner" to slow inflation.

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Brazil's economy fell short of forecasts once again in the first quarter, growing just 0.6 percent from the previous quarter. The weak data increased the likelihood of the third straight year of sub-par growth, underscoring Brazil's struggle to return to the boom years of the past decade.

The GDP reading put added pressure on Tombini, who faces the difficult task of taming inflation without undermining an economic rebound that is taking longer than expected to materialize.

A sharp weakening of the local currency, the real, on Wednesday raised fears of more inflationary pressures ahead as imports become more expensive.

President Dilma Rousseff, a pragmatic leftist who is up for re-election next year, has sought to resurrect Brazil's economy with a flurry of stimulus packages, cheap credit and tax breaks for targeted industries. A prolonged tightening cycle, however, could make it harder for the economy to kick into higher gear.

The last time the central bank raised the Selic by half a percentage point was in January of 2011 when a newly inaugurated Rousseff raced to tame a surge in activity that led the economy to grow 7.5 percent the previous year.

Also new to the job as head of the central bank, Tombini raised rates by an extra 125 basis points before abruptly reversing course in August of 2011.

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Since then economic activity seemed to be the main focus of the administration with the central bank slashing the Selic by 525 basis points as the Brazilian economy nose dived to grow only 0.9 percent in 2012.

Cloudy Inflation Outlook

Even after all those rate cuts, the recovery failed to fully materialize while inflation has come back with force after a brief reprieve in 2012.

In May, annual inflation eased slightly after briefly piercing the official target range ceiling of 6.5 percent. Inflation is expected to remain high in coming years in a country scarred by bouts of hyperinflation less than two decades ago.

Naggingly high inflation threatens to foil Rousseff's crusade to shore up the once-booming Brazilian economy before her bid for a second term in office next year.

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If price expectations recede following the steep rate hike, the central bank could be tempted to end the tightening cycle at its next meeting on July 10, some economists say.

"The statement implies that if inflation starts a downward trend in the 45 days before the next Monetary Policy Committee, the rate can stay at 8 percent," said Newton Rosa, chief economist with Sulamerica Investimentos in Sao Paulo.

Annual inflation slowed to 6.46 percent in the month to mid-May, just a shade below the target range ceiling of 6.5 percent but way above the bank's self-proclaimed target of 4.5 percent. The bank's own projections put inflation above 4.5 percent until the first quarter of 2015.

High inflation has forced Brazil to run counter to emerging markets from Mexico to Poland where central banks have slashed rates to stimulate domestic activity as the global economy remains lackluster.