Brazilian Central Bank Sees Faster Inflation This Year on 7.3% GDP Growth

Brazil’s economy may expand at the fastest pace in more than two decades in 2010, pushing inflation further above the government’s target this year and next, policy makers said in their quarterly inflation report.

Consumer prices will rise 5.4 percent this year, up from 5.2 percent forecast in the bank’s March report, as Latin America’s biggest economy grows 7.3 percent, according to policy makers’ base case scenario. The bank in March forecast growth of 5.8 percent this year.

Inflation will remain “well above” the government’s 4.5 percent target this year and slow to 5 percent in a “less challenging” scenario in 2011. In March, the bank had forecast inflation next year reaching 4.9 percent.

Today’s report doesn’t drastically alter the central bank’s “hawkish” view of the economy, said Jankiel Santos, chief economist at Banco Espirito Santo de Investimento. He estimates policy makers, led by President Henrique Meirelles, will raise the Selic rate to as high as 12.5 percent, enough to slow inflation to 4.6 percent in 2011.

“The central bank is not considering lower growth than the market is estimating,” Santos said in a telephone interview from Sao Paulo.

With the bank determined to contain inflation that has worsened since the first quarter’s stronger-than-forecast growth, the balance of risks is tilted toward even steeper rate increases, Santos said.

The real strengthened 1 percent to 1.7957 per U.S. dollar at 12:59 p.m. New York time from 1.8134 yesterday. In the overnight interest-rate future market, the yield on the contract due in January, the most traded on the Sao Paulo BM&F exchange, was unchanged at 11.34 percent. Yields on 14 of 16 contracts traded today rose.

‘Virtual Exhaustion’

Policy makers expressed concern that a recent increase in manufacturing costs has not yet affected consumer prices. Robust domestic demand may lead to a “virtual exhaustion” of spare capacity, they added.

“There is significant resistance to the fall of inflation in Brazil,” the bank said in the report. “Regular and almost automatic price-increase mechanisms, de jure and/or de facto, contribute to prolong inflationary pressures seen in the past.”

Brazilians may see an increase in disposable income and have more access to credit this year, central bank economic policy director Carlos Hamilton told reporters in Brasilia today. More credit makes the bank’s policy moves more efficient, he said.

“The effort to obtain a reduction in inflation rates today is less than was necessary to obtain a similar reduction in 2006,” Hamilton said. “Brazilian monetary policy is more effective as credit expands.”

Fiscal policy

“The central bank continues to talk tough, signaling it will maintain the monetary tightening,” Silvio Campos Neto, chief economist at Banco Schahin SA, said in a phone interview today from Sao Paulo. “The challenge in this scenario of more growth and inflation is how to reconcile fiscal and monetary policies, something we do not see currently.”

Brazil’s fiscal results this year are “more favorable” when compared with a year ago and the government may reduce spending while increasing investment as tax revenue recovers throughout the year, the bank said in the report.

The central bank “doesn’t contemplate” big fiscal policy mistakes this year and Brazil’s nominal budget deficit is “under control,”, Hamilton said.

“Our deficit is deficit is lower than many developed countries’,” Hamilton said. “We’re in an inverse situation, with a deficit under control and a decreasing net debt-to-GDP ratio.”

‘Main Risk’

Brazil’s economy expanded 9 percent in the first quarter over the same period last year, the biggest jump in more than two decades and the fastest-growing among the seven-biggest Latin American economies tracked by Bloomberg. Unemployment may end 2010 at a record 7 percent low, the bank forecast.

Policy makers have raised the benchmark interest rate twice this year to 10.25 percent to prevent the economy from overheating. The central bank will lift the Selic by 75 basis points for a third time in July, the bank’s weekly survey of about 100 economists published this week showed.

“On the domestic side, the main risk comes from the possibility that inflation and inflation expectations remain above target due to the increased use of productive capacity and expansion of domestic demand,” the bank said.

The report said the financial crisis in Europe continues to weigh on the economy and is the cause for some caution. Faster growth in Brazil is also boosting imports, which may jump 27.8 percent this year, while exports grow 12.6 percent, the bank predicted.

Inflation has remained above the government’s target every month this year, decelerating to 5.06 percent in the year through mid-June on lower food and transportation costs. Consumer prices will accelerate 5.55 percent this year, the central bank weekly survey of economists showed.

To contact the reporters on this story: Iuri Dantas in Brasilia at idantas@bloomberg.net; Arnaldo Galvao in Brasilia at agalvao1@bloomberg.net

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