Brazil hikes interest rates again to regain market confidence

Downtown Rio de Janeiro, Brazil
Vanderlei Almeida | AFP | Getty Images
Downtown Rio de Janeiro, Brazil

Brazil raised its benchmark interest rate to a 16-month high of 9 percent on Wednesday, maintaining the pace of monetary tightening to fight inflation and rebuild investors' confidence in Latin America's largest economy.

The central bank's monetary policy committee, known as Copom, voted unanimously for a third straight half-percentage-point rate hike to ease inflationary fears that have risen on the back of a plunge in the value of the local currency.

Forty-four of 46 economists polled by Reuters expected the bank to raise its Selic rate to 9 percent from 8.5 percent as part of a tightening cycle that started in April.

The central bank left the door open for more rate hikes by reiterating that the latest increase is part of a rate-adjustment process.

(Read More: Brazil central bank launches $60 billion currency intervention)

"Continuing the adjustment of the benchmark interest rate, Copom decided unanimously to raise the Selic rate to 9 percent," said the bank in its post-decision statement that repeated exactly the language of the last communique in July.

Monetary authorities from India to Indonesia are scrambling to offset the massive outflow of capital triggered by expectations of a withdrawal of stimulus in the United States and a stronger dollar. The exodus of investors have dragged down the value of currencies in most emerging-market nations, pushing inflation higher via pricier imports.

The stakes are even higher for Brazil where a mix of erratic policy that includes government intervention in sectors of the economy plus supply-side bottlenecks have severely hit investor confidence in the once-booming emerging-market nation.

Higher interest rates would help Brazil not only tame price increases, but also bolster investors' confidence, the International Monetary Fund said in a report about the South American nation published earlier on Wednesday.

The double-digit slump of the real had even prompted some market bets for a larger rate hike on Wednesday.

(Read More: Will Brazil be ready to host the World Cup in 2014?)

However, central bank President Alexandre Tombini threw cold water on those expectations by saying on August 19 that the steep rise in the yield of interest rate future contracts was excessive. The bank also launched a $60 billion intervention program to halt the plunge of the real, which has been one of the worst performing currencies in the world this year.

The scope of future rate hikes will likely hinge on the pace of depreciation of the real as well as the strength of the economic recovery in Brazil, analysts said.

"I think... (the central bank) will follow the data and decide accordingly. There will be at least another 50 basis points that will come in mid-October and we could see things heading on their way to 10 (percent) afterwards," said Jose Francisco de Lima Goncalves, chief economist with Banco Fator.

The central bank has argued that high inflation ultimately hurts the economy by discouraging investment in the country and domestic spending by local businesses and consumers.

The Brazilian economy likely rebounded in the second quarter, but recent data show that the recovery will again disappoint with growth of just 2 percent this year. Brazil's statistics institute will release second-quarter gross domestic product figures at 9 a.m. local time on Friday.

Erratic Policy

The bank started to raise the Selic in April after a spike in consumer prices, surprising investors with the aggressive pace of tightening that brought rates from record lows of 7.25 percent to 8.50 percent in July.

Annual inflation has eased since then, but at 6.27 percent remains well above the mid-point of the official year-end target of 4.5 percent, plus or minus two percentage points. Inflation expectations also remain high for next year.

A possible hike in gasoline prices in Brazil expected later this year could also fuel inflation by raising transport costs.

The inflation problem partly stems from a flurry of consumption-stimulus packages implemented by President Dilma Rousseff's government, which also raised tensions between her administration and the central bank, analysts have said.

(Read More: After Turkey, Brazil Hit by Widespread Protests)

The government's aggressive spending is seen as one of the main reasons why the central bank started to boost rates this year, even as the economy struggles to find its footing.

The likely normalization of monetary policy in the United States has added to inflationary concerns in Brazil, a country ravaged by bouts of hyperinflation in the 1980s and 1990s. Although analysts do not expect inflation to get out of control, authorities are under pressure to contain any surge in prices.

Finance Minister Guido Mantega has blamed the Fed for fueling a "mini-crisis" with mixed messages - about winding down or not, its liquidity expansion program (quantitative easing).

Adding to the uncertainty in markets is a likely military strike by the United States and allies on the Syrian government, which is accused of using chemical weapons against civilians.