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Brazil Suffers Assault on Bank Integrity With Tombini Rate Cuts

Brazil's Central Bank Chief Alexandre Tombini
Policy makers led by bank chief Alexandre Tombini, seen here, surprised all 62 analysts surveyed who forecast borrowing costs would be left on hold and instead cut the Selic rate a half-point to 12 percent. Photographer: Paulo Fridman/Bloomberg

Brazilian central bank board member Carlos Hamilton so disagreed with a surprise interest-rate cut in August that he slammed phones and stomped through hallways, according to three bank officials familiar with his reaction.

Hamilton and a second dissenter have since joined unanimous decisions to lower rates twice more as Europe’s debt crisis dents confidence in Brazil and the annual pace of price increases slows. Still, with economists predicting that a report tomorrow will show inflation last year reached 6.55 percent, exceeding the target range for the first time in eight years, his initial caution is timely.

Buoyed by record-low unemployment, consumer demand remains robust in the world’s second-biggest emerging market. Analysts surveyed by the central bank forecast that policy makers won’t hit their 4.5 percent inflation target until 2015.

The rate-cutting strategy is putting at risk the bank’s reputation as a guardian of price stability, said John Welch, chief emerging markets strategist for CIBC World Markets, the investment-banking arm of Canada’s fifth-largest bank.

Fighting inflation is a challenge in Brazil as President Dilma Rousseff presses to fulfill her pledge of slashing a 4.36 percent real interest rate that is the highest in the Group of 20 nations.

“They have to change their minds or completely give up inflation targeting,” Welch said by telephone from New York. “This was a risky bet they probably shouldn’t have made.”

Less Predictable

Brazil began targeting price increases in 1999 to tame a legacy of hyperinflation that peaked at 6,821 percent in 1990. Since then, interest-rate policy in Latin America’s biggest economy followed a familiar pattern where the benchmark rate rose and fell in tandem with inflation expectations, according to AllianceBernstein LP, a New York-based investment firm.

In August, that pattern became less predictable when the bank cut rates even before inflation began to ease, AllianceBernstein said in a September report.

Policy makers led by bank chief Alexandre Tombini surprised all 62 analysts surveyed by Bloomberg who forecast borrowing costs would be left on hold and instead cut the Selic rate a half-point to 12 percent. Coming after five straight increases, it was the most abrupt turnaround in monetary policy since 1999.

The bank at the time of the decision and in communications since said it needs to act in a “timely” way to offset a global economic slump. “Moderate adjustments” to its rate won’t compromise policy makers’ goal of bringing inflation to the 4.5 percent target in 2012, the bank said.

Praise for Cuts

The pre-emptive action has its supporters.

“They did well in anticipating the crisis,” said Andre Perfeito, chief economist with Sao Paulo-based Gradual Investimentos. “Trying to control inflationary pressures, mostly from services, would have had a huge social and economic cost -- it would have meant a recession.”

The breakeven rate, which reflects investors’ expectations of average annual inflation until 2013, was 5.8 percentage points yesterday, down from a three-year high of 6.5 percentage points Sept. 21. The gauge, derived from the yield difference between inflation-linked bonds and interest-rate futures contracts, averaged 5.39 percentage points since year-end 2008.

Other emerging market central banks, such as Thailand and Indonesia, also have cut borrowing costs as the global economic outlook worsened.

Growth Slowing

The 48-year-old Tombini’s pessimistic outlook is proving true in part, as investors’ appetite for riskier, emerging market assets wanes and slowing global demand cuts prices for iron ore, Brazil’s biggest export. Gross domestic product in the third quarter shrank for the first time since 2009, cementing expectations that growth last year slowed to 2.87 percent from 7.5 percent in 2010, according to a Dec. 30 bank survey.

The bank said “benign” commodity prices, stable fuel costs and falling domestic capacity use will help contain price pressures. Brazil’s broadest inflation index, which is 60 percent weighted in wholesale prices and is used to adjust everything from rents to utility rates, fell in December for the first time in five months.

Still, policy makers aren’t out of the woods.

While inflation has eased from 7.31 percent in September, economists expect tomorrow’s report to show the pace of price increases accelerated in December for a second month, pushing the year-end inflation rate to 6.55 percent last year--the highest since 2004. Inflation this year may reach 5.32 percent and is unlikely to return to the 4.5 percent target until 2015, the central bank survey shows.

“That August move should never have happened,” said Alexandre Schwartsman, a former central bank director from 2003 to 2006 and now a consultant in Sao Paulo. “They’ll realize they won’t make the target.”

Heated Job Market

Credit that’s expanding at an 18 percent annual pace, a heated job market and insufficient spending restraint are the main obstacles to slower inflation, Welch said. A 5.2 percent unemployment rate with rising real wages is bolstering consumer confidence that’s behind demand pressures, he said.

“All this means the central bank has to do more than it usually does to bring inflation down,” said Welch, who played soccer with Tombini while both were earning their doctorates in economics at the University of Illinois at Urbana-Champaign.

The August cut also fueled speculation of political meddling. A day before the surprise decision Rousseff vowed to take Brazil on a “new pathway” of lower borrowing costs “starting now.” The same week the government boosted its primary budget surplus target by 10 billion reais ($5.5 billion) to help pave the way for rate cuts, Finance Minister Guido Mantega said at the time.

“The poor communication, the surprise, and the announcement of the primary surplus led the market, including us, to suspect political interference,” Alessandra Ribeiro, a monetary policy analyst with Tendencias Consultoria Integrada, said by telephone from Sao Paulo.

Venting Frustration

Following the 5-2 vote presided over by Tombini, Hamilton vented his frustration to a colleague, saying that he was a technocrat not a politician, according to all three officials, who requested anonymity because of the sensitivity of the matter.

The second dissenter in the conference room on the 20th floor of the central bank’s modernist headquarters in Brasilia was likely Altamir Lopes, administrative director, the bank officials and economists familiar with his views said.

“I’ve known Altamir for years,” Carlos Thadeu de Freitas, a bank director in 1985-86, said by telephone from Rio de Janeiro. “He’s a rigorous monetarist and wouldn’t have supported such a risky move.”

The central bank in an e-mailed response refused to comment on how board members voted in August, or on Hamilton’s reaction. Hamilton and Lopes declined to comment when contacted through the central bank’s press office.


Unlike the Federal Reserve, Brazil’s central bank doesn’t reveal how each deputy governor votes. That’s in part to protect from scrutiny board members who, in the absence of independence for the bank, can be fired at any time. Proposals to grant board members fixed terms have little support in Rousseff’s Workers’ Party and have been stuck in Congress for years.

Like Tombini, both Lopes and Hamilton worked their way up through the ranks of the central bank. Lopes, 59, served as head of the bank’s economics department from 1995 until 2011. Hamilton, 47, joined the bank in 2000 and served as head of the research department before taking his current post as economic policy director in 2010.

The August dissent stemmed from disagreement over the timing of a rate cut and not the need for one, according to the minutes to the decision.

“Two members of the committee consider that the current moment still doesn’t offer all the necessary conditions for this move to take place immediately,” the minutes said.

Tension Easing

Since August, tension on the board has eased considerably, and Tombini and Hamilton remain close friends, according to two of the officials. The third-quarter contraction and three straight months of declines in industrial output have bolstered Tombini’s argument that inflation dynamics are under control.

The view among investors remains mixed. While traders expect the bank to keep cutting rates by as much as 100 basis points, they pared back their bets for the Selic to fall into the single digits for the second time since 1999 after the unemployment report was published Dec. 22. Yields on the interest-rate futures contract due January 2013 rose to 10.13 percent from 9.63 in late November, according to data compiled by Bloomberg.

With board members in agreement about tolerating higher inflation for the time being, there’s unlikely to be any opposition to further rate cuts, said Rogerio Mori, an economics professor at the Getulio Vargas Foundation business school in Sao Paulo.

“It’s a more dovish central bank than the last,” Mori said in a phone interview. “Perhaps the most dovish in a decade and a half.”

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