June 30 (Bloomberg) -- Brazil's central bank said the inflation rate will be higher than it previously expected for both 2004 and 2005 as an economic rebound gives retailers more room to pass on cost increases to consumers.

Central bankers boosted the 2004 forecast to 6.4 percent from 5.2 percent three months earlier and their 2005 forecast to 4.4 percent from 4.2 percent. Still, the 2005 forecast remains below the 4.5 percent target the government set, prompting economists such as Fator Doria Atherino's Vladimir Caramaschi to predict policy makers may seek to bolster the economic recovery by cutting interest rates later this year.

``They can resume rate-cutting by the end of the year because conditions for 2005 will permit it,'' said Caramaschi, chief economist for Brazil's largest brokerage.

Caramaschi said he expects the central bank to lower its benchmark overnight lending rate to at least 15.25 percent by yearend from a three-year low of 16 percent today. Central bankers have held the rate at 16 percent the past two months, after nine reductions in 11 months, on concern that a weakening currency and higher commodity prices will drive up the inflation rate in South America's biggest economy.

The central bank's 6.4 percent forecast for 2004 is above the government's 5.5 percent target. Under Brazil's inflation- targeting system, failure to keep the rate within 2.5 percentage points of the target would force the central bank to send a letter to the Finance Ministry explaining why it missed the target.

Council Meeting

The National Monetary Council, the government body that sets inflation targets, is scheduled to meet this afternoon to review the 2004 and 2005 targets and set a target for 2006.

All 27 economists surveyed by Bloomberg News said the council, headed by Finance Minister Antonio Palocci, Central Bank President Henrique Meirelles and Budget and Planning Minister Guido Mantega, will keep the 2004 and 2005 targets at the current levels. Twenty-one of 27 economists also said the council will set a 2006 target of 4.5 percent, matching the 2005 target.

Last year, the council raised the 2003 and 2004 inflation targets three weeks after President Luiz Inacio Lula da Silva took office because a 35 percent plunge in the currency in 2002 was driving up import prices.

Gustavo Loyola, an economist at Tendencias Consultoria in Sao Paulo and a former central bank president, said pushing up the target a second year in a row would erode investor confidence in the central bank.

`No End'

``A change in the inflation target is bad because the government is saying in principle it's willing to take on more inflation and there's no end to it,'' Loyola said at an event in Sao Paulo marking the 10-year anniversary of the introduction of a new currency, the real, that helped bring down annual inflation from as high as 5,000 percent. ``They will take a little bit more inflation and then a little bit more again tomorrow.''

Gustavo Franco, a former central bank president who now runs Rio de Janeiro-based Rio Bravo Investimentos, said an increase in the target may drive investment away.

``A person who wants to invest in Brazil to build a factory, when they see such types of discussion, he or she gets scared because they see a lack of confidence by the government to maintain stability,'' Franco said at the event in Sao Paulo. ``That's bad.''

The council is slated to meet after 4 p.m. (3 p.m. New York time) in Brasilia.

In its quarterly report, the central bank maintained its estimate for economic growth this year at 3.5 percent. The economy shrank 0.2 percent in 2003, its first contraction in 11 years.

To contact the reporter on this story: Carlos Caminada at ccaminada1@bloomberg.net

Last Updated: June 30, 2004 14:05 EDT