The FINANCIAL — Brazil’s central bank raised its benchmark interest rate by a half-percentage point on June 3 as inflation remained resilient despite strong signs of recession in Latin America’s largest economy, a condition often referred to as stagflation.
The bank moved the rate, known as the Selic, to 13.75% from 13.25%. The bank’s goal is to slow the 12-month inflation rate to 4.5% by the end of 2016, from 8.2% in April. The decision by the central bank’s policy makers was unanimous, according to Nasdaq.
The bank kept the wording of the announcement unchanged from the previous meeting, suggesting its monetary policy committee members want to leave open the option for more rate increases.
“It shows they’re really committed to reaching 4.5% in December 2016,” said Roberto Padovani, chief economist at the Votorantim brokerage in Sã o Paulo. Mr. Padovani is forecasting an inflation rate of 5% for December 2016. “They’ll look carefully at the inflation data” between now and the next meeting at the end of July.
The move comes a day after the country’s statistics agency said that industrial production declined 7.6% in April from a year earlier, and less than a week after it reported Brazil’s gross domestic product contracted 1.6% in the first quarter from the same period last year.
Economists surveyed by the central bank expect GDP to shrink 1.27% in 2015. In the same survey, forecasts are for a 12-month inflation rate of 8.3% at the end of this year.
The central bank’s inflation target is 4.5%, with a tolerance range of two percentage points in either direction. The 12-month rate has been above the center of the range for years, and will likely finish 2015 above the ceiling for the first time since 2004, when it hit 7.6%.
Raising borrowing costs is seen by many economists as necessary medicine to control inflation before growth can resume.
“Inflation is cost, hurts competitiveness and is a nasty regressive tax on low income households,” said Alberto Ramos, co-head of the Latin America Economic Research team at Goldman Sachs in New York. “We need to lower inflation to grow again,” he said.
The higher interest rate comes amid a government push to cut its budget deficit that economists say should take some pressure off prices, but could also slow growth.
Finance Minister Joaquim Levy has pledged to deliver a primary surplus, or government savings before interest payments, equal to 1.1% of GDP in 2015—a substantial improvement from last year’s deficit of 0.6% of GDP. The government unveiled last month a hefty 69.9 billion-real ($22.3 billion) cut to its 2015 budget plan.
The government still needs to do more to get its finances in order, according to Flavio Castelo Branco, an economist at the National Confederation of Industry.
“Fiscal reform needs to speed up,” he said. “The longer it takes, the higher interest rates will be.”
President Dilma Rousseff and Mr. Levy have been trying to demonstrate support for the central bank’s anti-inflation efforts in an attempt to help drive down forecasts that now put 2016 annual inflation at 5.5%, and not reaching 4.5% before 2019.
The relatively high forecasts are the result of policy makers’ dented credibility, critics say, and now Brazil’s central bank needs to go the extra mile to convince markets that it won’t budge in the fight against inflation.
“They start with negative credibility,” said Mauro Leos, from Moody’s Rating Services. “The only way to repair it is to state the goal and move towards it,” he said, adding that only when the median forecast for inflation from the central bank’s survey comes down to 4.5% will the bank be in a position to lower rates.
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