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Brazil Takes Sledge Hammer Approach by Hiking Rates

Yashuhide Fumoto | Photodisc | Getty Images

The latest interest rate hike by Brazil's central bank will "severely" affect the country's growth outlook and signals that the central bank is getting tough on inflation, analysts told CNBC.

"The myth of Brazil as a very very strong, ideal investment destination is definitely over," James Lockhart-Smith, principal analyst for Latin America at risk-consultancy Maplecroft, told CNBC on Thursday.

Brazil raised its benchmark interest rate to 8.50 percent from 8 percent on Wednesday in an attempt to battle inflation which is at a 20-month high in Latin America's largest economy.

Lockhart-Smith said the rate increase showed that the central bank was "finally getting serious" about inflation and that the Brazilian real, which has weakened almost 10 percent against the dollar over the last 12 months, was much weaker than the bank would like.

Last month, the central bank signaled it will act aggressively to meet its goal of bringing inflation below the 5.84 percent mark posted last year. It has hiked rates three consecutive times this year alone in its attempts to achieve its official inflation target of 4.5 percent - plus or minus two percentage points.

In June, however, annual inflation accelerated at the fastest pace in 20 months at 6.70 percent.

Rising prices have sparked widespread protests throughout Brazil and put pressure on President Dilma Rousseff to appease those protesting against poor public services and perceived corruption.

(Read More: Brazil's Rate Hike Harks Back to 2011, Without the Boom)

Lockhart-Smith said that there were many factors for Brazil's economic slowdown, citing a "cumulative loss of confidence during the year from investors."

But, rather than help the Brazilian economy, the latest rate hike would impede it.

"The country's growth profile will be pretty severely affected by this [rate increase]. The International Monetary Fund forecast for Brazil was revised down this week to 2.5 percent when it had been at 3 percent in April…but you could see growth being as low as 1.5 percent this year easily," Lockhart-Smith added.

Brazil's economy has slowed dramatically in recent years from 7.5 percent in 2010 to just 0.9 percent in 2012.

"Ten years ago it was enough for Brazil to be one of the BRICS, to be driven by really strong commodity demand and this credit expansion you had in the domestic economy and strong growth year after year. Looking forward things look a lot different," Lockhart-Smith said.

Chris Watling, the chief executive of Longview Economics, said Brazil's problems were characteristic of the downturn in emerging markets in general.

Speculation that the Federal Reserve will taper its monetary easing has sparked an exodus of U.S. dollars from emerging-markets like Brazil, where investors previously flocked in their search for higher yields.

(Read More: This Nation Could Be the Most at Risk From Capital Flight)

"Brazil is leading the charge in that [deterioration], much of that this year seems to be due to the fact that this year tapering's beginning and there's a strong U.S. dollar trend, and now you're fighting to keep the money in Brazil."

- Reuters contributed reporting to this story.