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Where now for Brazil after rates hiked for fifth month?

Thursday, 10 Oct 2013 | 7:59 AM ET
Andy Caulfield | The Image Bank | Getty Images

The central bank of Brazil faces a tough task getting its economy back on an even keel, experts told CNBC, after the country's main interest rates were raised for the fifth month in a row Wednesday.

Brazil's central bank raised interest rates to 9.5 percent from 9.0 percent in an attempt to fight above-target inflation of 5.86 percent. The move follows the announcement in August that it would launch a $60 billion intervention program to stem the Brazilian real's slide in value and rising import costs.

However, the hike in interest rates to mitigate the negative impact of inflation comes against a backdrop of slowing growth.

The country's gross domestic product (GDP) growth has slowed from 7.5 percent in 2010 -- when the economy was largely fueled by foreign investments, a credit boom and rising consumption -- to a predicted 2.5 percent in both 2013 and 2014, according to figures this week from the International Monetary Fund (IMF).

Adding insult to injury, the IMF said in its latest economic report this week that Brazil would suffer the lowest growth among its fellow emerging market economies, Russia, India and China.

Despite the slowdown, tackling inflation remained the central bank's key priority, Luis Costa, Emerging Market strategist at Citi, told CNBC. "The central bank is now clearly trying to fight this battle, trying to regain confidence and re-assert itself and show that it can bring inflation back to the target," Costa told CNBC Europe's "Squawk Box" on Thursday.

"But Brazil still has a serious problem of supply of infrastructure just like other EM (emerging markets) countries. Too much credit was pumped into the system towards the household sector but not towards the productive -- or potentially productive -- sectors of the economy," he added.

Costa said Brazil's infrastructure remained "extremely poor," a charge that reflects greater international anxiety about the country's ability to hold the soccer World Cup in 2014 and Olympic Games in 2016.

(Read more: Beer to get World Cup boost worth millions)

Brazil's ambassador to the U.K., Roberto Jaguaribe, denied that his country was ill-prepared for the events, however, saying that the majority of spending to host the games was being plowed into infrastructure projects which would in turn bolster growth.

"They have accelerated investments in infrastructure that was required, especially in transportation, airports and ports and there is also the investments in the stadia. Seventy-five percent of the cost of the World Cup is really infrastructure investment so that helps growth as well, " he told CNBC.

Brazil has 'enormous need' for infrastructure': Ambassador
Roberto Jaguaribe, Brazil ambassadot to U.K., says inflation remains Brazil's main priority and that the country is focusing on infrastructure investment as an engine for growth.

Despite being "very confident" about Brazil's ability to recover economically, "keeping inflation low is a must," he said, particularly with elections coming up in 2014. Inflation has become a political bugbear for the government which was confronted with widespread protests earlier this year over the rising cost of government spending on the World cup as they're own living costs rise in the face of inflation.

(Read more: Forget bank runs, credit crazy Brazil is heading for trouble)

James Lockhart Smith, principal Latin America analyst at Maplecroft, said that while Brazil faced a range of structural problems including an inadequate tax framework and overall business environment, inflation was indeed its central problem. Nonetheless, he added, that wouldn't stop the Brazilian the government trying to get the central bank to ease up on its monetary tightening stance ahead of elections next year.

"The government is eager to see growth restart, particularly ahead of elections so pressure will be brought to bear on the central bank against more rises," he told CNBC on Thursday.

Despite such pressures, there are indications that the central bank could continue to raise interest rates into double figures. Last week, the central bank's director Carlos Hamilton Araujo said there was still "a lot of work to be done" to battle inflation and the bank's own inflation projections predict it will remain above 4.5 percent –its target -- until the third quarter of 2015.

What could further determine how the central bank acts is whether the U.S. Federal Reserve decides to "taper" its bond-buying program which has helped foreign investments flowing into emerging market economies and their currencies.

(Read more: Emerging market taper terror 'quite overdone': Mobius)

The Fed was expected to start tapering in October but held off on the back of weaker-than-expected economic data. Now, with a political impasse over U.S. federal spending and the debt ceiling looming, not to mention the nomination of Fed dove Janet Yellen as the next Fed chairperson, tapering looks a more distant prospect.

Despite the prospect of U.S. stimulus continuing, Lockhart Smith did not think the Brazilian government would be tempted to turn its attention to growth measures rather than controlling inflation.

"The Federal Reserve's decision not to start tapering just yet is seen in Brazil as more a stay of execution rather than a reprieve," he said. "The monetary tide will reverse sooner or later."

"Unless there is an imminent change in the Fed's stance and it decides to start tapering very soon, I can't see the central bank changing its aggressive stance towards inflation," Lockhart Smith said.

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt