Brazil Raises Rate to 8.5% as Inflation Undermines Growth

Brazil’s central bank raised borrowing costs by half a percentage point for a second straight meeting, as the fastest inflation in 20 months undermines economic growth and fuels social unrest.

The bank’s board, led by President Alexandre Tombini, today voted unanimously to raise the benchmark Selic rate by 50 basis points to 8.50 percent, as forecast by all 51 economists surveyed by Bloomberg.

“The committee considers that this decision will contribute to put inflation on a decline and assure that this trend will persist next year,” policy makers said, according to their statement posted on the central bank’s website. The statement was virtually identical to their May 29 communique.

Rising prices helped spark the largest street protests in decades last month that also saw President Dilma Rousseff’s approval ratings plunge by almost half. Above-target inflation has undercut months of government stimulus by reducing consumer confidence and curbing retail sales and industrial output. After a quarter-point rate increase in April, policy makers doubled the pace in May and reiterated warnings that the outlook for inflation remains unfavorable.

“The diffusion of inflation remains widespread,” Andre Perfeito, chief economist at Gradual Investimentos, said by phone from Sao Paulo before today’s decision. “A higher Selic also seeks to boost credibility after the government implemented a loose fiscal policy.”

Inflationary Risks

Swap rates on the contract maturing in August, the most traded in Sao Paulo today, rose six basis points, or 0.06 percentage point, to 8.23 percent. The real weakened 0.2 percent to 2.2645 per dollar.

Policy makers, in their quarterly inflation report published June 27, said increased costs of food, fuel and public tariffs had contributed to a worsening of consumer and business sentiment. Consumer prices will rise 5.81 percent this year and the central bank will lift borrowing costs to 9.25 percent by November, according to a July 5 central bank survey of about 100 economists.

Consumer prices rose 6.70 percent in June from last year, the fastest pace since October 2011, the national statistics agency said July 5. The central bank targets inflation at 4.5 percent, plus or minus two percentage points.

Protesters took to the streets in early June to oppose a bus fare increase in Sao Paulo. Discontent later spread to other metropolitan centers including Brasilia, Porto Alegre and Rio de Janeiro, as demonstrators expanded their grievances to include corruption, public services and government spending on stadiums for next year’s World Cup.

Falling Short

Rousseff’s approval rating fell to 30 percent, down from 57 percent before protests started and a high of 65 percent in March, according to a survey by Datafolha published June 29.

The real’s depreciation to its lowest level in more than four years may further fuel inflation, according to Roberto Padovani, chief economist at Votorantim Ctvm. The real has weakened 12.8 percent in the last three months, the worst performance among the 16 most-traded currencies tracked by Bloomberg, as the Federal Reserve signaled it may begin to scale back U.S. monetary stimulus.

“The central bank is working to control inflationary risks,” Padovani said by phone from Sao Paulo before today’s decision. “That is why they are raising rates.”

Faltering Economy

Since May 29, when the government reported that growth of gross domestic product unexpectedly slowed to 0.55 percent in the first quarter, a number of key economic indicators have missed expectations.

Retail sales, which helped propel Brazil’s economic expansion in recent years, grew less than half the pace of analysts’ estimates in April and will contract in May for the second time in 2013, according to the median estimate from 27 economists surveyed by Bloomberg. The statistics agency reports on sales tomorrow.

Lojas Renner SA, Brazil’s biggest clothing retailer, is one of the companies that has seen its business outlook deteriorate on inflation concerns. The company’s share price on June 28 declined to the lowest level since August after JPMorgan Chase & Co. cut its recommendation on the stock due to declining disposable income and deteriorating consumer sentiment.

Industrial output declined 2 percent in May, lower than all 29 forecasts of analysts surveyed by Bloomberg. The same week, analysts cut their economic growth forecasts for Brazil for this year and next to below 3 percent for the first time, according to the July 5 central bank survey.

“Economic activity is weak, and that’s a sign that inflation continues to be high,” Darwin Dib, chief economist at CM Capital Markets Asset Management, said by phone from Sao Paulo before today’s decision.

Cautious Position

Citing a need to rein in spending, Finance Minister Guido Mantega on June 27 decided to gradually unwind tax cuts on home appliances. Days later, Rousseff said that fiscal control helps contain inflation.

While the government’s fiscal pledges may help to anchor inflation expectations, higher commodity prices and a weaker exchange rate could prevent prices from easing in upcoming months, said Jose Francisco de Lima Goncalves, chief economist at Banco Fator.

“There are a series of uncertainties that justify a cautious position,” Goncalves said by phone from Sao Paulo before today’s meeting. “As long as 12-month inflation remains above 6 percent, the situation is risky.”

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