UPDATE 3-Brazil leaves door open for smaller interest rate hikes

Alonso Soto and Silvio Cascione
Thursday, 5 Dec 2013 | 9:05 AM ET

(Adds analyst comments, details and context)

BRASILIA/SAO PAULO, Dec 5 (Reuters) - Brazil's central bank said on Thursday its string of six interest rate hikes have had a lagging effect on inflation, signaling policymakers could be ready to slow one of the world's most aggressive monetary tightening cycles.

The central bank raised its benchmark Selic interest rate by 50 basis points to 10 percent last week to curb inflation, but signaled in its decision statement that it may slow the pace of rate hikes to focus more on economic growth.

In the minutes of that meeting released on Thursday, the bank said it considered it appropriate to continue the pace of rate hikes then, and that it needs to continue to be "especially vigilant" about inflation.

However, in a shift from recent policy statements, the bank acknowledged that "the transmission of the effects of monetary policy actions on inflation occurs with lags."

That phrase was interpreted by many analysts to mean that the bank could afford to slow the pace of hikes now because the previous increases will take longer to take affect.

"The bank is leaving the door open for a slowdown, but it is not committed to it necessarily," said Gustavo Rangel, chief economist for Latin America with ING in London. "The bank is calling attention to what it has done and in a way suggesting that much of the job has taken place."

Yields on interest rate futures <0#2DIJ:> were up slightly as traders considered that the central bank did not commit itself to a slower pace of rate increases.

The bank's president, Alexandre Tombini, is under heavy pressure to end a monetary cycle that has added 275 basis points to the Selic to avoid undermining an already fragile recovery of Latin America's largest economy.

A larger-than-expected contraction of the economy in the third quarter underscored the difficulties President Dilma Rousseff faces to jump start an economy that has struggled to grow during her three years in office. The Brazilian economy shrank 0.5 percent in the third quarter versus the previous one after a sharp fall in investment.

Those disappointing growth figures may push the 8-member monetary policy committee to opt for a smaller rate hike at its Jan. 15 meeting even if inflation remains high.

In the minutes, the bank said its own projections for inflation this year fell when compared to the previous meeting, while its inflation forecast for 2014 remained stable.

The return to double-digit interest rates marked a setback for Rousseff, a leftist economist who has promised to bring down borrowing costs. At 10 percent, the Selic is one of the highest benchmark interest rates among major economies.

Finance Minister Guido Mantega already blamed rising rates for having "some impact" on economic growth so far this year, in what some analysts saw as a message to monetary policy authorities.


Annual inflation has eased since peaking in June but remains well above the center of the target of 4.5 percent, plus or minus two percentage points. Brazil's benchmark IPCA consumer price index rose 5.84 percent in the 12 months through October.

A sharp depreciation of the Brazilian real, which has shed 7 percent of its value in just over a month, could stoke inflation and be the determining factor for the path of future monetary policy.

"I believe the central bank is very worried about the impact a weak real could have on inflation," said Luis Otavio Leal, chief economist for Banco ABC Brasil in Sao Paulo. "The big question for the central bank now is the exchange rate more than economic growth."

A smaller-than-expected increase in domestic fuel prices announced last week means less inflationary pressures for what's left of this year. However, lack of clarity about a new formula to adjust fuel prices in the future raised further doubts about the government's ability to keep inflation in check.

The rapid deterioration of Brazil's fiscal accounts in the last two years has also taken a toll on Rousseff's credibility, prompting warnings of a credit downgrade from major rating agencies as the budget deficit widens.

Rousseff has promised to rein in spending and roll back some tax breaks to replenish state coffers, but the government's over reliance on extraordinary revenues to meet fiscal targets is harshly criticized by investors.

Fears of an exodus of foreign capital when the United States starts to unwind its massive stimulus program could also hit the Brazilian economy in coming months.

(Additional reporting by Brad Haynes; Writing by Alonso Soto; Editing by Todd Benson, W Simon and Chris Reese)