Brazil Swap Rates Rise on Inflation Outlook; Real Strengthens

Brazil’s swap rates climbed to a two-month high after the central bank said the outlook for inflation is worsening in the “short term,” fueling bets policy makers will raise borrowing costs to contain prices.

Swap rates due in January 2015 increased 10 basis points, or 0.10 percentage point, to 7.96 percent, the highest level on a closing basis since Nov. 23. The real appreciated 0.2 percent to 2.0310 per dollar.

While minutes of the central bank’s most recent meeting repeated that the target lending rate will stay at a record low 7.25 percent for a “sufficiently prolonged period,” policy makers’ decision to highlight inflation shows there is a chance borrowing costs may be increased, according to Marcelo Fonseca, an economist at M. Safra & Co. in Sao Paulo.

“The central bank recognized a deterioration in inflation expectations, though saying the problem is short-term,” Fonseca said in a telephone interview. “The bank is saying it will maintain rates, but if inflation becomes permanent and not just short-term, perhaps it will have to raise them.”

Investors expectations for annual consumer prices plunged 29 basis points today to 5.45 percent, according to the so-called breakeven rate for 2015.

Annual inflation has exceeded the 4.5 percent midpoint of the central bank’s target range for 28 consecutive months. The IPCA index of consumer prices rose 5.84 percent in December from a year earlier after increasing 5.53 percent in the prior period, the national statistics agency reported Jan. 10.

The IPCA-15 consumer price index increased 0.88 percent in the month through mid-January, compared with 0.69 percent in the prior period, the national statistics agency reported yesterday. The highest forecast of 38 economists surveyed by Bloomberg was for a 0.86 percent advance.

Electricity Costs

Brazilian President Dilma Rousseff announced in a televised address last night that the country will lower energy costs this year more than the government previously announced and make the cuts effective today as part of an effort to slow inflation. Reductions were previously planned for next month.

The president said the cuts today will pare consumers’ power costs by 18 percent and those for industry by 32 percent compared with the reductions of 16.2 percent and 28 percent she had announced in September.

Even with the deeper electricity cuts, inflation will quicken by midyear toward 6.5 percent, the ceiling of the central bank’s target range, Enestor Dos Santos, an economist at Banco Bilbao Vizcaya Argentaria SA, said by e-mail.

Economic Outlook

While Dos Santos said weak growth and the use of other tools to control prices will allow the central bank to hold rates stable this year, he added that quickening inflation and a change in policy makers’ tone “practically closed the door to a rate cut and triggered talks about an upward adjustment.”

The economy expanded an estimated 1 percent last year, according to central bank estimates, down from 2.7 percent in 2011 and 7.5 percent in 2010.

The central bank board held the benchmark interest rate at 7.25 percent on Jan. 16 for a second straight meeting. Slower-than-expected domestic economic activity is due to “supply limitations” and can’t be addressed by monetary policy, the central bank said in its minutes.

“Between the lines of the central bank minutes was a signal or recognition that imports play an important role in the supply and demand balance, and there is a need for the real to appreciate,” Carlos Thadeu de Freitas Gomes Filho, an economist at Franklin Templeton Investments, said in a phone interview from Sao Paulo.

Policy makers swung in 2012 between selling currency swaps to prevent the real from falling too quickly and offering reverse currency swaps to protect exporters by keeping the real from strengthening beyond 2 per dollar.

The currency has rallied 1.9 percent since Dec. 20, when Carlos Hamilton, the central bank’s director for economic policy, said officials consider an exchange rate of 2.05 as more “adequate” when creating economic forecasts than 2.10.