Brazil Plays Fool in the Shower With Interest Rates

As Brazil central bank President Alexandre Tombini wraps up a two-day policy meeting in Brasilia today, there’s one thing his three-year tenure has proven is almost certain: he will not leave interest rates unchanged.

In 22 of the 25 meetings Tombini has overseen since taking over in 2011, the central bank’s board has raised or cut rates, making it the most active among major emerging economies. He raised benchmark borrowing costs five times and then cut them 10 times before undertaking a fresh series of increases in April. He will lift the key rate a quarter-point today to 10.75 percent, marking the eighth straight increase, according to a majority of economists surveyed by Bloomberg.

In the lexicon of the late Nobel Prize-winning economist Milton Friedman, Brazil is mimicking the “fool in the shower.” Friedman drew an analogy between the policy maker who aggressively changes rates to someone who finds the water in the shower too cold and impatiently overcompensates by making it scalding hot. Tombini has been carrying out one of the world’s most aggressive increases since April to curb inflation after he cut rates to a record low 7.25 percent in a bid to stoke growth.

“You’ve had a number of swings in rates driven by fundamentally misguided policies,” said Paulo Vieira da Cunha, a former central bank board member who is now chief economist at Ice Canyon LLC, in a telephone interview. “Brazil ended up with too much of an expansionary policy, though given problems of supply side, the economy didn’t grow. Nevertheless, you did end up creating inflationary pressures.”

Swap Rates

The central bank’s press department declined to comment on benchmark interest rate moves when contacted by phone.

Forty-four of 61 economists surveyed by Bloomberg predict a quarter-point increase today. Sixteen analysts expect a seventh straight 0.5 percentage point increase, while one expects no change. The bank is scheduled to announce its decision after 6 p.m. in Brasilia.

The swings in benchmark borrowing costs over the past three years have pushed swap rates on contracts due in January 2015 to as high as 12.94 percent and as low as 7.38 percent. They fell to 11.01 percent as of 1 p.m. in New York today, indicating traders expect Tombini to raise the Selic by a quarter-percentage point today.

Inflation has withstood the slowest two-year period of growth in more than a decade as the currency weakened. Consumer prices as measured by the IPCA-15 index rose 5.65 percent in the year through mid-February, the national statistics agency said on Feb. 21.

Spending Cuts

While inflation has slowed from a near two-year high of 6.7 percent in June, it has remained above the midpoint of the central bank’s 2.5 percent to 6.5 percent target range since August 2010. The currency has slumped 15.3 percent in the past year, driving up the cost of imports.

Economists in a weekly central bank survey this week cut their 2014 growth estimates to 1.67 percent, the lowest ever and down from expectations of 3.80 percent last February.

Finance Minister Guido Mantega said on Feb. 20 the government will cut $18.8 billion from its 2014 budget as part of a plan to help the central bank fight inflation. The reduction will slow inflation and also help monetary policy be “less severe,” Mantega told reporters in Brasilia the same day. Government officials had previously cut taxes on items from cars to home appliances and increased spending in efforts to spur growth.

‘Misguided Policies’

“Fiscal policy is forcing Tombini to be more hyperactive,” Enestor dos Santos, an economist at BBVA, said in a phone interview from Madrid. “We’ve been tightening for almost a year now. Tombini has been changing rates since the first meeting.”

Tony Volpon, the head of Americas research at Nomura Securities International, said Brazil is nearing the end of its cycle of rate increases and that the country’s monetary policy will start to look more like that of developing-nation peers.

“They should stop soon, because the rate is about where it should be,” Volpon said in a telephone interview from New York. “So this hyperactive central bank that is the most busy in major emerging markets should come to an end. We should see policy be more like in other places.”

Tombini’s record of 22 rate changes in 25 meetings, or 88 percent, is more than twice the frequency of Colombia, which at 43 percent is the region’s second-most-active central bank among major Latin American economies. Mexico in the same period has changed borrowing costs 12 percent of the time, the least among the region’s banks.

Rating Outlook

Whether Tombini will adopt a less frenetic rate-setting policy depends largely on the government delivering on its promise to cut spending, said Joao Junior, fixed-income broker at Icap Brasil DTVM in Sao Paulo.

Brazil’s budget deficit swelled to the equivalent of 3.28 percent of gross domestic product in the 12 months through December, according to central bank data.

Standard & Poor’s in June placed Brazil’s rating on negative outlook while Moody’s Investors Service in October lowered its outlook to stable from positive, citing deteriorating debt ratios and slow growth. Brazil’s Baa2 rating from Moody’s and equivalent BBB ranking from S&P are the second-lowest investment grades.

“Tombini has a lot more work to do because of the way the government has directed fiscal policy,” Icap’s Junior said.

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