Brazil: An Old Foe Is On the Rise

While central bankers around the world are focusing on weaker growth, policymakers in Brazil are concentrating on an old foe: increasing inflation.

Consumer prices rose 0.46% from January to February. That was down from January's 0.57% rise, but above private forecasts of 0.35%. For the 12 months ended in February, prices increased 6.2%. That's even with the 6% rate for 2000, but above the central bank's 2001 target of 4%.

Several factors could lift the inflation rate. First, Brazil's economy may be stronger than expected for 2001. After jumping 6.6% in December, industrial production fell back by only 2.7% in January. Auto production has been particularly strong.

Second, the central bank is counting on falling oil prices to offset other price rises. But the recent production cuts announced by OPEC make it less certain that world energy costs will drop this year. In addition, Brazil lost 6% of its oil output capacity when the Petrobras oil platform exploded on Mar. 15. The platform fell into the sea on Mar 20.

Third, and perhaps most important, the Brazilian real has fallen to a two-year low on currency markets. Since the start of this year, the real has dropped 7.3% (chart). The central bank has intervened to stem the weakness, but with little success. If the real keeps falling, however, higher import prices could raise total inflation even more.

The real's weakness can be traced to Brazil's widening current account deficit, as well as the political woes in neighboring Argentina. Currency traders are worried that Argentina's new Economy Minister will not be able to turn around that country's economy, which has been in a recession for three years. Argentina is one of Brazil's major trading partners and a recovery there is essential if Brazil is to send more exports that way.

For now, Brazil's central bank is sticking with its inflation target of 4%. And while that goal still looks achievable, events outside of the bank's control could derail its best-laid plans.

By James C. Cooper & Kathleen Madigan

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