Brazil Raises Rate to Highest Since 2009 as Real Fuels Inflation

Brazil’s central bank raised borrowing costs to the highest level in almost six years on price pressure from a weakening currency and kept its options open on the size of the next increase.

The board, led by President Alexandre Tombini, voted unanimously Wednesday to maintain the pace of tightening with a half-point increase to 12.75 percent, as expected by 59 of 63 economists surveyed by Bloomberg. Four analysts forecast a rate of 12.50 percent. Policy makers took into consideration “the macroeconomic scenario and the inflation outlook,” according to their statement, which was virtually unchanged from the prior meeting.

“They had no choice but to continue tightening at that pace with such a huge correction in prices,” John Welch, a strategist at Canadian Imperial Bank of Commerce, said by telephone after the decision. “They may cut the pace to 25 basis points, but that doesn’t mean they’re done.”

President Dilma Rousseff’s new economic team, spearheaded by Finance Minister Joaquim Levy, is unwinding tax breaks and allowing government regulated prices to rise in an effort to shrink last year’s record budget deficit. The policies, coupled with a real that weakened to a 10-year low Wednesday, are fanning inflation and threaten to damp an economic recovery.

Annual inflation accelerated to 7.36 percent in mid-February as prices surged 1.33 percent in the month. Policy makers have responded to cost of living increase by lifting the key rate 0.50 percentage point at three straight meetings, giving Brazil the highest inflation-adjusted borrowing costs among the Group of 20 nations.

Options Open

While keeping the text of Wednesday’s statement unchanged suggests continuity of monetary policy, the central bank is keeping its options open on the pace of tightening, Thais Zara, chief economist at consulting firm Rosenberg Consultores Associados, said by phone.

The central bank may provide the market with more guidance in its inflation report on March 31, when there could be more clarity on the trend of the currency and progress of the government’s budget cuts, she said.

Since the bank’s prior meeting in January, the real has declined 12.7 percent to extend its six-month slide against the dollar to 25 percent, the worst performance among the world’s 16-most traded currencies. The currency fell 1.6 percent Wednesday to 2.9798 per dollar from 2.9316 on Tuesday, its weakest level since 2004.

Zara said she didn’t expect the decision to move markets on Thursday.

Austerity Measures

“It already was counting on this decision,” she said, adding that investors will be looking for news on whether Congress accepts the Rousseff administration’s fiscal policies.

Levy and Tombini on Feb. 23 and 24 urged lawmakers to drum up support for the government’s austerity measures, including reductions in some pension and unemployment benefits that would save 18 billion reais ($6 billion) a year. The minister, who took office in January, already has capped federal spending on some items and raised taxes on fuel, imports, credit and cosmetics.

The economic team last week also announced plans to roll back breaks on payroll taxes to help offset an estimated 60 billion reais in revenue shortfalls. Senate President Renan Calheiros rejected the measure, forcing the administration to re-submit it as a bill rather than a provisional decree that goes into effect immediately.

Economic Stability

Some lawmakers such as Calheiros are concerned about the effect of the government’s measures on the economy, which analysts surveyed by the central bank see heading for its worst contraction since 1990. Growth in Brazil has trailed the regional average for the last four years.

Government reports last month underscore the economy’s weakness.

Retail sales in December declined a month-on-month 2.6 percent, the most in 15 years, while unemployment jumped to 5.3 percent -- the highest level since September 2013 -- from 4.3 percent a month earlier. Brazil also recorded the worst result in the formal labor market in January since 2009 as the economy shed 81,000 jobs.

Policy makers in their next meeting in April will weigh the impact of a slowing economy with the pass-through effects of a weaker real, Carlos Kawall, chief economist at Banco Safra, said by telephone from Sao Paulo.

“It will be a battle between currency and growth,” he said after the decision.

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