Brazil’s central bank surprised analysts by accelerating the pace of interest rate cuts, bringing borrowing costs below 10 percent for only the second time amid signs of lackluster growth in Latin America’s biggest economy.
In a split vote yesterday, policy makers led by bank President Alexandre Tombini cut the Selic rate by 75 basis points to 9.75 percent. Two dissenting members voted to lower the rate by a half point for a fifth straight meeting.
“They just lost patience,” said Nomura Securities’ Tony Volpon, one of just two economists who anticipated the move in a Bloomberg survey of 62 analysts. “The government clearly is afraid, given what they know up to now, that 2012 could be another weak growth year, and they want to buy insurance against that.”
A report yesterday showing industrial production in January fell by the most in three years may have tipped the balance in favor of a deeper cut.
The government believes that “drastically” reducing real interest rates that are the second-highest in the Group of 20 richest nations after Russia will also help fight currency gains, said Volpon, the chief emerging markets economist for the Americas at Nomura, in a telephone interview. The real has gained 31 percent since 2008, the second-biggest gainer of the 25 most-traded emerging market currencies tracked by Bloomberg after the Chilean peso.
The bank’s one-sentence statement didn’t explain why it was acting more aggressively, though Volpon expects another 75 basis point cut in April followed by a half point reduction to 8.5 percent in May.
The yield on the interest rate futures contract maturing in January 2013 fell 23 basis points, or 0.23 percentage point, to 8.68 percent at 11:40 a.m. Brasilia time, its biggest drop since Sept. 1, the day after the central bank began its rate cutting cycle.
The real weakened 0.7 percent to 1.7781 per dollar.
The bank’s strategy may heighten inflation concern. Even after the pace of price increases has slowed in recent months, economists are doubtful that Tombini can fulfill his pledge to lower inflation to the government’s 4.5 percent target as unemployment hovers near a record low and credit growth of 18 percent fuels consumer demand.
Forecasts for 2013 inflation have risen in each of the three previous weekly central bank surveys of economists, to 5.2 percent. In January inflation was 6.22 percent, down from 7.31 percent in September.
Tombini began lowering the benchmark rate in August, saying in each of the meetings before yesterday that “moderate” reductions in borrowing costs would shield the economy from the euro debt crisis. In January the bank said there was a “high probability” the rate would drop to less than 10 percent as inflation concerns subside.
Traders Less Surprised
Traders boosted bets for a bigger rate cut this month as evidence mounted that the economy is growing at a level weaker than was previously expected.
The 2.1 percent decline in industrial output in January, the biggest drop since December 2008, followed a report this week showing that Brazil’s economy last year had its second-worst performance since 2003. Gross domestic product expanded 2.7 percent in 2011, less than Brazil’s neighbors and below the 3 percent growth by Germany amid the euro debt crisis.
Besides lowering borrowing costs, Rousseff’s government has cut taxes on consumer goods and is boosting public investments to ensure 4.5 percent growth this year. Economists expect weaker growth of 3.3 percent, according to the most recent bank survey.
“They knew that they wanted to get to a single digit and they saw a window of opportunity to accelerate,” said Alberto Ramos, chief Latin America economist at Goldman Sachs & Co. Still, Ramos cautioned against predicting a deeper easing cycle than the market was anticipating, saying that policy makers may simply be frontloading already-planned cuts.
“It could be that the growth and inflation picture will change by May, and then it’s not as easy to continue to cut,” he said in a telephone interview from New York yesterday.
Since Brazil began targeting inflation in 1999, the Selic has only once before fallen below 10 percent, in the wake of the 2008 global financial crisis.
Roberto Padovani, chief economist at Votorantim Corretora, said the bank’s strategy will depend increasingly on non-monetary tools such as tighter banking regulations to contain inflation.
“Economists have to understand they’ve changed their instrument,” Padovani said yesterday in a phone interview from Sao Paulo, adding the Selic may fall to 8.5 percent during the current easing cycle.
Roberto Setubal, chief executive officer of Itau Unibanco Holding SA, Latin America’s biggest bank by market value, said Brazil has room to cut interest rates further amid weak growth and inflation globally.
“Without a doubt people have to understand well that the world is going through a moment with very low interest rates,” Setubal told reporters in Rio de Janeiro today.
A rally in the currency that is hurting manufacturers that compete with cheaper imports is also a top concern. Brazil’s benchmark rate is a magnet for investors borrowing at near-zero rates abroad. So far this year, $15.5 billion has entered the country, compared with investment outflows of $3 billion in the last quarter of 2011.
Rousseff, on a trip to Germany this week, said her government would spare no effort to protect manufacturers from a “monetary tsunami” triggered by loose credit conditions in Europe and the U.S. The real has strengthened 5.2 percent against the dollar this year, the fifth-biggest gainer among the 16 most-traded currencies tracked by Bloomberg.