Brazil Balks Last Minute at Raising Rates and Angers Critics

  • The real and swap rates fell on Thursday after surprise hold
  • Decision is `blow' to bank's credibility -- Neil Shearing

Almost from the moment he took over Brazil’s central bank five years ago, Alexandre Tombini has heard the cries of critics who swear he’s in cahoots with politicians hell-bent on growth at all costs. His decision Wednesday night to unexpectedly refrain from raising interest rates will do little to quiet that talk.

It wasn’t just the decision alone. It was the unusual circumstances leading up to it. On Tuesday morning, hours before Tombini initiated the two-day policy meeting, he issued a curt statement saying he and his colleagues would take into consideration a new IMF report predicting a bigger economic contraction in Brazil this year. The implication was clear: Don’t expect an increase in rates to tame inflation, not now, not when the economy is this weak.

It was a rather unorthodox step, one that caused a mini-scandal (with those same critics saying Tombini broke protocol), deepened the sense of confusion in Brazilian financial markets and highlighted the extent of the predicament policy makers are in. Inflation may have soared above 10 percent for the first time in 12 years, but the economy could shrink by more than 3 percent for a second straight year. And policy makers don’t know which lever to pull on.

“The central bank was already short on credibility with regards to inflation targeting and today’s decision is a further blow,” Neil Shearing, chief emerging markets economist at Capital Economics, wrote in research note Wednesday. “We can now add the issue of central bank autonomy to an already long list of reasons to be concerned about the direction of Brazil’s economy.”

The Brazilian real fell 1.4 percent to 4.1552 per U.S. dollar, its weakest in nearly four months. Short-dated interest-rate swaps fell after Tombini’s Tuesday statement and plunged further after the surprise no-change decision, which was celebrated in the presidential palace according to several media reports. 

Swap rates maturing in January 2017 slipped 26 basis points to 14.89 percent. While traders still bet the central bank to resume interest rate increases this year, Santander is predicting Tombini will cut the key rate to 13 percent by the end of the year.

Economic Woes

Reasons to be concerned about Brazil include rising unemployment, shrinking industrial production, falling retail sales and a widening federal budget deficit. To make matters worse, impeachment proceedings against the president and a growing corruption scandal have increased infighting in Congress, making it nearly impossible for lawmakers to agree on measures to revive growth.

The International Monetary Fund as a result revised downward its estimates for gross domestic product on Tuesday, forecasting a contraction of 3.5 percent this year and stagnation next. That would mark the longest period without growth in over a century.

While the downturn could justify a decision to keep interest rates unchanged, the central bank didn’t communicate that strategy in the weeks leading up to the meeting, according to Thais Zara, chief economist at consulting firm Rosenberg Consultores Associados. Tombini instead hammered on the message that he would bring inflation down to target by the end of next year, before changing course by publishing the note on IMF forecasts.

Political Pressure

Tombini’s statement came two days after Brazilian newspaper Estado de S. Paulo reported that the ruling Workers’ Party would pressure him to lower borrowing costs. That was the latest in a string of news reports saying policy makers are being pushed to defend the ruling party’s agenda to stimulate growth. Party leader Rui Falcao last month said lifting interest rates would do more to hurt investment than it would to contain inflation.

“This gives the impression that they used the IMF as an excuse,” Zara said. “It’s hard to say to what extent politics influenced things -- if they did at all -- but the market will assess that possibility.”

The central bank’s press office declined to comment when asked whether politics played a role in its decision. Finance Minister Nelson Barbosa also said Thursday he wouldn’t discuss the central bank’s decision, saying it has autonomy to set rates and that consumer price increases are expected to slow.

"There’s a chance of having a positive surprise on inflation, with it falling more than the market currently expects," Barbosa told reporters in Davos, Switzerland, adding inflation rates could fall to 6.5 percent or a bit lower in 2016.

Policy makers said in a statement accompanying the decision they took into consideration increased uncertainties, especially those abroad. Two of the board members dissented and voted for a 50-point hike.

Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., said the decision will undermine the bank’s credibility and shows a weaker commitment to fighting price increases.

“I wouldn’t be surprised if the central bank starts talking about cutting,” he said.

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