Brazil’s central bank unexpectedly cut interest rates as the risk of recession in Europe and the U.S. shifted policy makers’ focus away from the fastest inflation in six years.
The bank’s board, led by President Alexandre Tombini, voted 5-2 to cut the benchmark rate a half point to 12.0 percent after raising rates at each of the previous five meetings. All 62 analysts surveyed by Bloomberg had forecast rates would be left on hold.
“Re-evaluating the international scenario, the Committee considers there was a substantial deterioration, reflected in generalized reduction of great magnitude in the growth projections for the major economic blocs,” policy makers said in their statement posted on the central bank’s website.
A selloff in world stock markets, which lost nearly $5 trillion this month as Europe tried to stave off a sovereign debt crisis and global growth showed signs of slowing, was a “game changer” for emerging markets that had been focused on cooling their economies, said Marcelo Salomon, chief economist for Brazil at Barclays Plc.
“We experienced a very important negative shock,” Salomon said in a telephone interview from New York before today’s decision. “With the risks skewed toward deflation and disinflation, all central banks are pausing and trying to gauge when it’s going to be time to start cutting rates.”
Anticipated by Traders
With today’s reduction, Brazil became the second country in the Group of 20 Nations after Turkey to lower borrowing costs in response to the worsening global outlook. On Aug. 26, Mexico also signaled that it may follow suit.
Brazilian President Dilma Rousseff this week redoubled efforts to control spending to help stem inflation that surpassed 7 percent in August for the first time since 2005. The government this week raised its target for the 2011 budget surplus before interest payments by 10 billion reais ($6.3 billion), after tax collection jumped by 30 percent in June and July.
Finance Minister Guido Mantega argued that such a move would “open space” for a reduction in interests rates, while Rousseff yesterday vowed to take Brazil on a “new pathway” of lower borrowing costs “starting now.”
Today’s cut had been anticipated by traders, who were pricing in reductions in the Selic of as much as one percentage point this year, according to Bloomberg estimates based on interest rate futures. On Aug. 29, traders had been pricing in a 72 percent chance of a cut, then pared back their bets yesterday and today.
Policy makers are betting that slower growth and declining demand from China for Brazil’s iron ore and other commodities exports will stem price increases without the need for further monetary tightening.
Tombini said he expects the inflation rate to start falling in September, and has pledged to hit the 4.5 percent mid-point of the bank’s target range by the end of 2012.
Inflation, as measured by the IPCA-15 index, accelerated to 7.1 percent in the 12 months through mid-August. The IGP-M index of wholesale, construction and consumer prices rose more than expected in August, after falling in June and July.
The price increases are weighing on consumer sentiment, reinforcing expectations that Latin America’s biggest economy is slowing.
No Fiscal Stimulus
Consumer confidence fell 1.1 percent in August, according to a survey published by the National Industry Confederation, while business confidence in the second quarter fell to its lowest level since 2009. Industrial production in July fell 0.3 percent from a year earlier, while the bank’s economic activity index fell in June for the first time since 2008.
“They are seeing less growth and less inflation, and the risks of the international environment are much higher,” said Maristella Ansanelli, chief economist at Sao Paulo-based Banco Fibra SA. She forecasts four half point rate cuts starting in October.
UBS AG and Citigroup Inc. this month cut their forecasts for expansion of the world economy and predicted major central banks will leave interest rates on hold through 2012.
Both Mantega and Rousseff have signaled they won’t increase spending if growth in the world economy halts, as Brazil did following the collapse of Lehman Brothers Holdings Inc. in 2008. That has fueled expectations that the central bank could take advantage of another slowdown to aggressively cut its benchmark rate, which is the highest in the G-20.
The high Selic rate is also a magnet for investment. Dollar inflows have surged to $61 billion so far this year, putting pressure on the real whose 46 percent rally since the end of 2008 is the biggest among 25 major emerging market currencies tracked by Bloomberg.
The yield on the interest rate futures contract maturing in October 2011, the most traded in Sao Paulo today, rose 2.5 basis points, or 0.025 percentage point, to 12.29 percent. The real rose 0.3 percent to 1.5896 per U.S. dollar. The currency has appreciated 46 percent since the start of 2009, the most of 25 emerging market currencies tracked by Bloomberg.
While Tombini is being helped in his inflation fight by commodities prices, which have fallen 11 percent since the end of April, economists still expect him to miss his 2012 inflation target as domestic demand is buoyed by a tight labor market and easy credit.
Analysts held their 2012 inflation forecast unchanged at 5.20 percent in the most recent central bank survey, and raised their forecast for 2011 inflation to 6.31, from 6.28 percent the previous week.
Unemployment in July fell to 6.0 percent, its lowest level this year. Total outstanding credit expanded 19.8 percent in the year through July, even after repeated attempts by policy makers to slow its growth.
The U.S. Commerce Department last week revised down its number for second quarter GDP growth to 1 percent from 1.3 percent. Christine Lagarde, the managing director of the International Monetary Fund, warned Aug. 27 that the world economy is in a “dangerous new phase.”
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