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Brazil Inflation High Following Interest Rate Cut
Sept. 09, 2011

Published by Minyanville

Brazil is beginning to calm after last week’s shock decision to cut interest rates to 12%, after five consecutive rises aimed at curbing the country’s soaring inflation and overheating economy. As analysts cool, questions are being asked on the reasoning behind the move as the impacts become ever so slightly clearer.

The primary reason that Brazil’s interest rates are so high is a need for the country to curb growing inflation. At best, news that 12-month inflation hit its highest level since June 2005 after the interest rate cut can be blamed on bad timing. The figure for the 12 months through August was 7.23%, well above the government’s year-end target of 4.5%.

The new figures are blamed partly on food prices. This coupled with higher prices in the service sector has pushed figures up to this six-year-high. However, they come during a week that analysts are watching Brazil’s economy with even wider eyes than usual.

“There’s an element of wishful thinking,” Alberto Ramos, a senior Latin America economist at Goldman Sachs in New York, told Bloomberg. “Inflation expectations have not improved. The recent activity prints show that activity is still pretty solid.”

The decision last week to cut the rate took into account a “substantial deterioration” in global markets, as well as slow domestic growth, according to the Central Bank. There was even concern that the move was a political one, ordered by President Dilma Rousseff. However, this appears to have been quashed by a source close to her, who told Reuters: “This was a surprise for us, too. We thought it would be unchanged, or (the Central Bank) would cut by 25 (basis points). No one expected 50.” Rousseff’s surprise was corroborated by a second official, according to the news agency.

“Rousseff's reaction raises other, perhaps equally worrying questions,” write Isabel Versiani and Brian Winter for Reuters. “If the decision surprised even her -- a trained economist who meets regularly with Central Bank chief Alexandre Tombini -- then was the rate cut clearly premature?” They also ask why the bank was unwilling to communicate intentions better to both the markets and officials.

Following an uncharacteristically long statement on its reasoning when the cut was announced last week, the Central Bank today elaborated on the decision. The minutes of the policy meeting in which the decision was made reveal that they believe the long-term outlook for the global economy is weaker than after 2008’s crisis. The bank’s economic modeling predicted, “The deterioration in the international scenario would be more persistent than that seen in 2008-2009 but less acute in the absence of extreme events.”

The minutes also signal that rates may continue to fall. “To mitigate in a timely way the effects coming from a more restrictive global environment, moderate adjustments in the basic rate are consistent with inflation converging to the target in 2012,” the minutes read. The bank expects inflation to slow in the third quarter. The real strengthened slightly on the release of the minutes.

Of 62 economists polled by Bloomberg, not one predicted last week’s rate cut. The same was true of 20 analysts surveyed by Reuters. Samantha Pearson of the Financial Times writes that “danger, risk, and loss of credibility,” were the buzzwords bandied about by analysts when the news broke. Tombini has even earned a nickname, Pombini, a play on the Portugese word for dove.

On the eve of the country’s Independence Day celebrations, Rousseff insisted that Brazil’s domestic market would be protected amid international chaos. "In the case of the current international crisis our principal weapon is to expand and defend our internal market, which is already one of the most vigorous in the world,” she said. “That's why I want to make it clear that my government won't allow attacks on our industry and our jobs.”

Thanks in part to an inflated real, manufacturers are struggling to export competitively, while Brazil eats up imports, notably from China. “We will never allow foreign goods to compete unfairly with our products,” Rousseff said.

To this end, the government has levied import taxes on Chinese steel tubes. An anti-dumping tariff of $743 is to be levied on each ton of steel piping imported from China, valid for a period of five years. The pipes are used in Brazil’s booming oil industry, injected with billions of dollars of cash thanks to state oil firm Petrobras.

The president, who has come under much criticism recently for both the economy and the corruption that mars her government, added that inflation was under control, even going as far as to “guarantee” economic stability. Thousands of Brazilians celebrated the country’s independence by demonstrating against corruption in Brasilia, after multiple scandals have hit Rousseff’s government in recent months.




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© Girish Gupta