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Brazil's central bank faces growing concern on rate hikes
May 28, 2015 / 7:57 PM / 3 years ago

Brazil's central bank faces growing concern on rate hikes

BRASILIA/RIO DE JANEIRO, May 28 (Reuters) - Brazil’s central bank risks causing unnecessary damage to a struggling economy if it raises interest rates even more in coming weeks, a growing number of economists and business leaders warn.

Central bank chief Alexandre Tombini has already increased the benchmark Selic rate by 3.25 percentage points since October, taking it to a whopping 13.25 percent even though the economy is expected to shrink at least 1 percent this year.

Brazil’s rate hike cycle, the most rigorous among major economies in 2015, is an effort to tamp down inflation, currently running at above 8 percent, and regain investor confidence after some of President Dilma Rousseff’s leftist economic policies backfired.

Brazil’s interest rates are already the highest among the world’s 10 largest economies.

Recent comments by central bank officials have led financial markets to believe that Tombini and his board will raise the Selic by another 50 basis points when the board next meets on June 2-3. Some are pricing in additional increases at subsequent gatherings in July and September.

After overwhelmingly supporting Tombini’s efforts in the last few months, economists from some of Brazil’s leading banks have begun voicing misgivings.

In recent interviews with Reuters, several expressed concern that Tombini risks going too far given the weaknesses in Latin America’s largest economy. Unemployment rose to a four-year high of 6.4 percent in April, data showed last week.

“Because of the recession, (inflationary) pressure is already very weak. In that sense, raising rates further is an exaggeration,” said José Francisco de Lima Gonçalves, chief economist at Banco Fator, in Sao Paulo.

Octavio de Barros, head of economic research at Banco Bradesco, said it was “understandable” that the bank was trying to bring inflation down, but added: “Keeping interest rates unchanged would be enough.”

Tombini reiterated on Tuesday that monetary policy has to stay “vigilant” to bring inflation down to its target of 4.5 percent by end-2016, a comment that many in financial markets interpreted as a harbinger of coming rate hikes.

The central bank itself currently forecasts 2016 inflation to stay above that goal, at 4.9 percent.

Recent comments by central bank director Luiz Awazu Pereira at closed-door meetings with economists also sounded hawkish, participants said, by reiterating the bank’s “vigilance”.

A central bank spokesman said the bank would not comment on the opinions of market analysts.

UNEMPLOYMENT RISING

Economists’ growing criticism has been echoed in the business world. Just after the central bank last raised the Selic on April 29, Brazil’s largest industrial association called on policymakers to rethink their strategy.

Officials within Rousseff’s economic team have expressed discomfort with the continuation of rate hikes in recent private conversations with Reuters, but stopped short of criticizing the central bank.

Interest rate hikes have discouraged investments in recent months, worsening Brazil’s downturn. Farmers, for example, have nearly halved purchases of harvesters in the first quarter because of tighter credit, according to the national automakers’ association.

The rate hikes are part of a broad push by Rousseff’s government to regain credibility following her re-election to a second term last October. She has also raised taxes, appointed a much more market-friendly finance minister, Joaquim Levy, and announced plans to freeze about $22 billion in government spending this year.

Despite the tightening, inflation has been stubbornly high because of recent sharp rises in government-managed prices such as electricity, and also lingering mistrust of the central bank after it slashed rates to record lows in 2011-12, a move many think was a mistake.

“This is a central bank that has lost its credibility, so they need to go the extra mile to restore it,” said Paulo Vieira da Cunha, a former director at Brazil’s central bank between 2006 and 2008.

Analysts warn the central bank risks being overzealous with rates for another reason - because models for predicting future inflation are not reliable enough to predict the impact of larger-than-expected unemployment.

That issue was brought up by analysts during the meetings with central bank’s Pereira, participants said.

No economist advocated cutting the Selic anytime soon. But instead of raising rates, some suggested that the bank could more effectively control expectations by communicating clearly that it has no intention to start bringing the Selic down in early 2016 as markets currently expect.

Last week, a senior member of the government’s economic team told Reuters that policymakers would only consider reducing borrowing costs once their projections show inflation easing below the center of the target.

“There are no reasons to believe the economy will exit recession this year,” Fator’s Gonçalves said. “Stopping the rate hikes would be good.” (Additional reporting by Alonso Soto in Brasilia; Editing by Brian Winter and Kieran Murray)

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