Brazil Signals Key Rate Raises May Be Resumed After Election

Brazil’s central bank signaled it may resume interest rate increases it interrupted yesterday, after presidential elections in October.

The bank’s board, led by its President Alexandre Tombini, said it decided “at this moment” to keep the Selic rate at 11 percent. Yesterday’s decision ended the world’s longest tightening cycle in the past year and was forecast by 46 of 53 economists surveyed by Bloomberg.

“The language they used suggests this may just be a tactical pause,” Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., said from New York. “Inflation is not converging to target over the two-year horizon. After the elections, they will have to reevaluate.”

President Dilma Rousseff’s administration is struggling to tame inflation, which has remained above target for almost four years, without further jeopardizing growth. Higher prices are eroding consumer and business confidence. Under her watch, gross domestic product expanded at the slowest average pace for a Brazilian president since Fernando Collor, who stepped down in 1992.

Traders, who correctly predicted the central bank would keep rates unchanged yesterday, are betting the Selic may be raised as early as December, swap rates show.

Swap rates on the contract due in July 2014, the most traded in Sao Paulo today, fell 3 basis points, or 0.03 percentage point, to 10.813 percent at 3:55 p.m. local time. The real strengthened 0.4 percent to 2.2239 per U.S. dollar.

Consumer Prices

Consumer prices rose 6.31 percent in the 12 months through mid-May, the biggest gain in 10 months. Analysts predict they will continue to accelerate to 6.47 percent by December, according to the median estimate in a central bank survey of economists published this week. Policy makers target inflation of 4.5 percent, plus or minus a two percentage-point margin.

Wholesale, consumer and construction prices, as measured by the IGP-M index, fell 0.13 percent this month as a drop in raw materials helped offset gains in health care, apparel and construction labor costs, the Getulio Vargas Foundation said on its website today. That was the first decrease in the IGP-M since November 2012.

The government will need to increase utility, fuel and transport prices that it had capped, fueling inflationary pressure and forcing the central bank to boost rates in 2015, said John Welch, macro strategist at Canadian Imperial Bank of Commerce.

‘Repressed Inflation’

“They’ll have to undo all this repressed inflation,” Welch said by phone from Toronto. “They have a very difficult task ahead of them.”

Higher prices and slower growth has reduced support for Rousseff’s re-election bid. Her approval rating fell to 47 percent in May from 55 percent in November, according to a May 15-19 Ibope poll.

Growth in Latin America’s biggest economy slowed to 0.2 percent in the first quarter over the three previous months, according to the median estimate in a Bloomberg survey of 38 economists. The national statistics agency is scheduled to release its first-quarter growth report tomorrow.

A slowing economy coupled with political constraints meant the rate increases had to end, said Enestor Dos Santos, principal economist at Banco Bilbao Vizcaya Argentaria.

“There are always political costs involved when raising the benchmark rate,” Dos Santos said by phone before yesterday’s decision. “Now we are closer to the elections, and the cost is higher.”

Industry Sentiment

Consumer confidence, as measured by the Getulio Vargas Foundation, this month fell to the lowest level in more than five years while statistics published by the National Industry Confederation showed industry sentiment at the lowest since January 2009.

Auto-parts maker Sifco SA last month said it would halt payments on its dollar-denominated bonds. The Brazilian company, which supplies front axles for trucks and buses, said an economic slowdown led to a reduction in revenue and cash flow.

The central bank paused to avoid suffocating already weak activity, said Roberto Padovani, chief economist at Votorantim Ctvm Ltda. Brazil’s economic growth will slow to 1.8 percent in 2014 and remain below the Latin American average for the fourth straight year, according to economists surveyed by Bloomberg.

Since April 2013, Brazilian policy makers raised rates by 375 basis points, more than any other central bank after Turkey’s to combat consumer price increases.

They will have to lift borrowing costs to 12.5 percent by the December 2015 to ensure inflation remains under control after the election, said Flavio Serrano, senior economist at Banco Espirito Santo de Investimento.

“The central bank will be forced to hike again” Serrano said by phone from Sao Paulo. “That is why they included the phrase ‘at this moment’.”

Before it's here, it's on the Bloomberg Terminal.