Brazil Holds Key Rate at 11% as Economy Risks Stagflation

Brazil kept borrowing costs unchanged for the second straight meeting, as slowing growth gives the central bank no leeway to raise rates with inflation running above the upper limit of its target.

The bank’s board, led by its President Alexandre Tombini, today held the benchmark Selic at 11 percent, as forecast by all 57 economists surveyed by Bloomberg. The central bank lifted borrowing costs by 375 basis points in the year through April before halting May 28.

Policy makers said they “decided unanimously, at this moment, to keep” borrowing costs unchanged after evaluating the outlook for growth and inflation, according to their statement posted on the central bank’s website.

President Dilma Rousseff is facing waning growth and the fastest inflation in a year less than three months before seeking re-election. Faltering consumer and business confidence have undercut activity from family consumption to investment and prompted economists to cut their growth forecast for this year to 1.05 percent. Even as the central bank says consumer prices will hover near the top of its target range in 2014, policy makers held the key rate to avoid further damage to demand, said Newton Rosa, chief economist at Sul America Investimentos.

“This is a bad combination that typifies stagflation,” Rosa said by phone before today’s decision. “Weak growth limits the possibility of new rate increases. On the other hand, you have inflation levels that are still very elevated and reduce the chance of a cut.”

Record Low

Swap rates on the contract due in January 2015, the most traded in Sao Paulo today, fell one basis point, or 0.01 percentage point, to 10.76 percent. The real weakened 0.2 percent to 2.2235 per U.S. dollar.

Brazil’s government this year said it would increase social spending, make permanent payroll tax cuts in 56 industries and lure billions of dollars in infrastructure investments to spur growth. Finance Minister Guido Mantega said as recently as last month that economic growth will gather momentum in upcoming quarters.

Analysts in a weekly central bank survey think those efforts will fail to revive activity. They cut their expectations for growth in 2014 to a record low of 1.05 percent on July 11, compared with a 2.5 percent expansion last year.

Dimmed Prospects

Economists’ growth estimates mirror readings of household and corporate confidence. Industrial sector sentiment as measured by National Confederation of Industry dropped last month to the lowest level in over a decade, while consumer confidence has hovered near five-year lows.

Gross domestic product grew 0.2 percent during the first quarter, half the pace of the expansion recorded in the final three months of 2013. Growth in agriculture was offset by the biggest contraction in investments in two years.

The central bank lifted the benchmark Selic by 375 basis points in the year through April. Brazil now has the highest borrowing costs among rate-setting nations in the G-20. The bank targets annual inflation at 4.5 percent, plus or minus two percentage points.

Additional key rate increases would crimp new investments and dim chances of faster growth toward the end of the year, said Italo Lombardi, an economist at Standard Chartered International.

Direcional Engenharia SA (DIRR3), a Brazilian homebuilder that sells to low-income families, is one of the companies that has seen sales slow in recent months. Its stock tumbled the most in a year on July 11 after booked sales sank in the second quarter. MRV Engenharia e Participacoes SA, which also targets low-income consumers, fell the same day.

‘Aggressive Cycle’

“Investors are cautious and, with rates that high, it reduces the incentives for capital expansion,” Lombardi said by phone before today’s announcement. “If the central bank hikes more, it could trap the economy.”

Brazil’s inflation last month slowed to 0.40 percent from 0.46 percent in May, as food and beverage prices eased. Annual inflation increased to 6.52, the highest level in 12 months.

Monthly inflation should remain well-behaved in coming months, the central bank’s Tombini said in the transcript of a July 1 interview posted on the central bank’s website. Prices have not been fully affected by previous monetary tightening, he said.

“There are lags between monetary policy and the impacts on the economy,” Lombardi said. “It was a very aggressive cycle.”

Weaker Real

The central bank said last month it was extending through the end of 2014 a currency intervention program aimed at helping boost the real. The plan, which was first announced last August, has helped the currency gain 6.2 percent this year, the most among emerging markets.

A weaker real may fan consumer prices by making imports more costly.

For Enestor Dos Santos, principal economist at Banco Bilbao Vizcaya Argentaria, the central bank does not want its inflation fight to jeopardize economic activity.

“That’s the bias that this central bank has,” Dos Santos said by phone before today’s decision. “They pay attention to growth, and not only inflation.”

To contact the reporter on this story: Matthew Malinowski in Brasilia at mmalinowski@bloomberg.net

To contact the editors responsible for this story: Philip Sanders at psanders@bloomberg.net Robert Jameson, Harry Maurer

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