Brazil Says Highest Key Rate in Nine Years to Tame Inflation

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Brazil’s central bank says keeping interest rates at the highest level in nine years for a prolonged period will bring inflation back to its target by the end of 2016.

The central bank board, led by bank President Alexandre Tombini, voted last week to lift the benchmark interest rate for the seventh straight meeting, by 50 basis points to 14.25 percent. Foreign affairs director Tony Volpon abstained from voting after public comments made by him were seen by lawmakers as improperly previewing his vote.

The central bank “considers that the scenario for inflation to converge toward 4.5 percent at the end of 2016 has strengthened,” policy makers said Thursday in the minutes to their July 28-29 meeting. “The committee considers that holding that interest rate level for a sufficiently prolonged period is necessary for the convergence of inflation toward the target at the end of 2016.”

Brazil faces the double threat of an inflation rate that is twice the government target and the prospect of the worst recession in 25 years. Policy makers have increased the key rate by 325 basis points since October to fight rising prices. Slowing growth has crippled revenue to the point that Finance Minister Joaquim Levy had to cut the government’s fiscal target even as Brazil faces the risk of a credit downgrade to junk.

“Their intention is not to have any more key rate increases,” Jose Goncalves, chief economist at Banco Fator, said by phone. “The central bank is indicating there are important effects of monetary policy that still haven’t been felt yet.”

Swap rates on the contract due in January 2017, the most traded in Sao Paulo today, rose 20 basis points, or 0.20 percentage point, to 13.96 percent at 9:36 a.m. local time. The real weakened by 0.9 percent to 3.5166 per U.S. dollar

S&P Review

Annual inflation in mid-July accelerated to 9.25 percent, the fastest pace in more than a decade and more than double the central bank’s target range of 4.5. Monthly inflation was 0.59 percent, below analysts’ median estimate.

Standard & Poor’s last month revised the outlook for Brazil’s sovereign credit rating down to negative, citing the economic slowdown. Brazil sits one level above junk and a downgrade would mean losing investment-grade status.

Latin America’s largest economy will contract 1.8 percent this year, according to a central bank survey of economists published Aug. 3. Growth is expected to rebound to 0.2 percent next year.

Tax Collection

The slowdown has eroded tax collection, according to Levy, prompting the economic team on July 22 to cut the primary budget surplus target for the year to 0.15 percent of GDP from 1.1 percent.

The government is still pushing Congress to approve the latest austerity measures. Levy said Wednesday that the government needs to finish the adjustment before pursuing growth.

“The central bank is concerned about fiscal policy and has warned that there are risks to the credibility of macroeconomic policy,” Italo Lombardi, economist at Standard Chartered Bank, said by phone. “They have assured they will remain vigilant.”

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