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Brazil May Pause at 10.75% After Inflation Slows

Brazil’s central bank will probably keep its benchmark interest rate unchanged today after three straight increases as inflation has slowed below target and the global economic recovery falters.

Policy makers, meeting for the last time before October’s presidential election, will hold the benchmark rate at 10.75 percent, according to 46 of 57 economists surveyed by Bloomberg. Seven economists forecast a quarter-point increase, and four expect a half-point rise, betting higher borrowing costs are needed to prevent a rebound in inflation next year.

Since growing at the fastest pace in 15 years in the first quarter, Latin America’s biggest economy has slowed, bringing consumer prices in August below the government’s target for the first time since January. With slower growth curbing inflation, the bank is likely to take a wait-and-see approach to better gauge whether the global recovery has stalled, said Marina Santos, chief economist at Squanto Investimentos in Sao Paulo.

“They don’t know, we don’t know, and nor does Bernanke,” Santos, who expects the central bank to hold rates this week, said in an interview. “It’s better to wait than risk over-tightening at a moment of global uncertainty.” Santos was one of three analysts among 51 surveyed by Bloomberg in July who correctly predicted the bank’s unexpected half-point rate rise.

Traders’ Bets

By the time the bank meets again after the Oct. 3 elections, policy makers may have a better sense of both the vigor of the global economy and domestic inflation, Santos said.

The difference between yields on the overnight interest rate futures contract due in January 2011 and 2013 suggest that some traders are speculating that the bank will need to resume rate increases in the months ahead.

The spread between the contracts’ yields rose to 90 basis points today at 1:07 p.m. New York time, or 0.9 percentage point, up from 53 basis points on Aug. 24. The real strengthened 0.8 percent to 1.7420 per dollar.

The bank will probably resume raising rates early in 2011 as slower global growth won’t be enough to hold inflation to the bank’s target of 4.5 percent, plus or minus two percentage points, said Jankiel Santos, chief economist at Banco Espirito Santo de Investimento.

Policy makers will probably implement a last 0.25 percent increase in tomorrow’s meeting to anchor inflation expectations on a downward path, Santos said.

Pace of Recovery

Central bank President Henrique Meirelles said Aug. 18 that growth will heat up again in the third quarter.

“There will be a recovery -- the question is to what level of activity and inflation,” Meirelles said in an interview with GloboNews TV network. “The central bank cannot signal what it doesn’t know.”

Meirelles, who has served as the bank’s president since 2003, has vowed to step down when a new government takes office on Jan. 1.

Dilma Rousseff, former cabinet chief and President Luiz Inacio Lula da Silva’s chosen successor, has a 24 percentage point lead over opposition candidate Jose Serra, according to an Ibope poll published Aug. 28. With 51 percent support, Rousseff would win in the first round, according to the poll.

Brazil’s $1.57 trillion economy may have expanded 0.5 percent to 1 percent in the second quarter, Finance Minister Guido Mantega said this week. Growth will accelerate to an annual rate of 6.5 percent to 7 percent by year-end, he added.

Analysts predict the economy expanded 0.8 percent from the first quarter, according to the median estimate in a Bloomberg survey of 40 analysts. The country’s statistics agency releases its second-quarter gross domestic product report on Sept. 3.

New World

Brazil’s central bank has expressed concern about the outlook for the global economy, and data from the U.S. seem to indicate a prolonged period of low growth, said Virgilio Castro Cunha, head of fixed income strategy at Bank of America Corp. in Sao Paulo.

“We’re living in a new world that will work with low real interest rates for a long time, making it more comfortable for investors in Brazil,” said Cunha, who predicts the Selic will remain unchanged this week.

Brazil’s consumer prices unexpectedly fell in the month through mid-August, pushing the annual rate to 4.44 percent, down from 5.22 percent in mid-April.

Even as 2010 inflation expectations fall, forecasts for 2011 have increased to 4.87 percent, from 4.8 percent four weeks ago, according to a central bank survey of about 100 economists published this week.

Political Risk

There is a political risk premium on bonds maturing after 2010, due to uncertainty among traders whether a Rousseff government might tolerate higher levels of inflation, said Roberto Padovani, chief economist at Banco WestLB do Brasil SA.

Rousseff, on the campaign trail, said she wouldn’t reduce the government’s inflation target if elected. In an interview this week with TV Globo, she said it was a “crime” to defend spending cuts.

“She’s not that hawkish in terms of fiscal or monetary policy,” Padovani said, speaking by telephone from Sao Paulo.

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