Brazil Signals More Cuts After Reducing Rate to Record Low

Brazil cut its benchmark interest rate to a record low and signaled it will lower borrowing costs further as a fragile world economy contains inflation risks.

Policy makers led by bank President Alexandre Tombini voted unanimously to lower the Selic rate by a half-point to 8.5 percent last night, as forecast by 61 of 70 analysts surveyed by Bloomberg. Policy makers, in a statement, said that inflation risks are “limited” and that “fragility” abroad is having a “disinflationary” impact in Latin America’s biggest economy.

Brazil has cut borrowing costs by four percentage points since August, the most in the Group of 20, to try and revive growth. The monetary stimulus and efforts to prop up spending through tax cuts have yet to kick in as the economy unexpectedly contracted in March after shrinking in January and February. A report today showed industrial output shrank in April for the ninth time in 10 months.

“The statement increases the chances that interest rates will be cut to below 8 percent,” said Roberto Padovani, chief economist at Votorantim Ctvm Ltda.

While Padovani isn’t changing for now his call for two more quarter point cuts before the easing cycle ends, he said the bank left the door open for a half-point cut at its next meeting in July and more after that.

The yield on the interest-rate futures contract maturing in January 2013, the most traded in Sao Paulo today, fell seven basis points at 9:55 a.m. Brasilia time. The real weakened 0.1 percent to 2.0187 per U.S. dollar.

Traders’ Bets

Traders are already wagering the Selic will fall to at least 8 percent by August, according to Bloomberg estimates based on rate futures contracts.

“There is no reference in the statement to suggest the potential near-term ending of the current easing cycle,” Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., said in an emailed statement.

World stock markets have lost about $3.9 trillion since the start of May as investors speculate that Greece could leave the 17-nation euro zone this year.

The extra yield investors demand to hold Spain’s 10-year bonds instead of similar-maturity German notes yesterday soared to 5.37 percentage points, up from 4.01 percentage points on April 12. The spread of Brazil’s U.S. dollar bonds over Treasuries has risen 55 basis points to 2.38 percentage points over the same period, according to JPMorgan Chase & Co.

The turmoil in Europe and a slowdown in China, the biggest buyer of South America’s commodities, has been hobbling growth. The central bank’s seasonally adjusted economic activity index, a proxy for gross domestic product, fell 0.35 percent in March, surprising all 18 economists in a Bloomberg survey whose median forecast was for 0.49 percent growth.

Slow Recovery

The economy’s recovery from a contraction in the third quarter has been slower than expected, Tombini said May 21. GDP likely expanded 0.5 percent in the first three months of the year, according to a Bloomberg survey of 46 analysts ahead of tomorrow’s first quarter growth report. Factory output fell in 13 of 27 sectors.

While low unemployment and increased credit have sustained demand, industrial output fell 0.2 percent in April and 2.9 percent from a year, the national statistics agency reported today.

Policy makers last week redoubled their efforts to spur spending, freeing up 18 billion reais ($8.9 billion) in reserve requirements held at the central bank so that lenders can boost credit to car buyers. Auto sales fell 10.8 percent in April from the year before, leading Daimler AG’s Mercedes-Benz unit and Volvo AB to temporarily halt assembly lines in Brazil.

Economists are doubtful Brazil can spend its way back to faster growth, and in a central bank survey this week cut their forecast for 2012 growth to below 3 percent for the first time this year.

Savings Rules Triggered

Finance Minister Guido Mantega has also abandoned the government’s goal of 4.5 percent growth this year. Brazil will grow more slowly this year than Russia, India and China, according to the International Monetary Fund.

Yesterday’s rate cut aids President Dilma Rousseff’s drive to reduce interest rates that less than a decade ago stood at 26.5 percent and are still the second-highest in the G-20. It also triggers the end of government-guaranteed returns on savings accounts that could’ve led investors to dump fixed-income assets as borrowing costs fall to unseen lows. Under the new rules announced this month, the accounts will pay 70 percent of the Selic when the key rate falls to 8.5 percent or lower.

Interest rates charged on Brazilian consumer loans fell close to record lows this month, as the government stepped up pressure on private banks to reduce what Rousseff called “unacceptable” spreads.

Inflation Concern

Even as manufacturing is weak, inflation remains a concern. The pace of price increases slowed for a seventh month in April, to 5.1 percent, and economists forecast inflation will stay above the bank’s 4.5 percent target through 2013.

A 14 percent decline by the real over the past three months, the most of 31 major currencies tracked by Bloomberg, is also raising the cost of imports. The IGP-M price index, which is heavily weighted in wholesale goods that reflect the currency’s slide impact on imported materials, rose in May at the fastest pace in 18 months.

Still, the tax cuts and a seasonal decline in clothing and food purchases should restrain price pressures in the near term and inflation is likely to end the year at 5 percent or lower, said Flavio Serrano, a senior economist at Espirito Santo Investment Bank.

“We may see inflation by the end of this year quite close to the target,” Serrano said before the rate decision, adding that he expects the central bank to raise the Selic to 9.5 percent next year as inflation accelerates to 6 percent. “The problem is next year, as the lagged effects of monetary policy and these measures to boost consumption take effect.”

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