Brazil raises interest rates as emerging economies step up their fight against inflation

04/29/2010 10:08 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Brazil’s central bank, Banco Central do Brazil, raised interest rates as expected yesterday, April 27.

But the bank also did the unexpected. The increase in the benchmark Selic rate to 9.5% from 8.75% was more than most economists and analysts had expected. 30 of the 54 economists and analysts surveyed by Bloomberg before the increase had projected a 0.5 percentage point move instead of the actual 0.75 percentage point hike.

The interest rate increase is the first by any Latin American bank in more than a year.

In a one sentence statement announcing the decision the central bank didn’t indicate how fast or far interest rate increases would go. But economists say that the bank is likely to raise rates at its next four to six meetings.

The rate increase is a response to forecasts predicting that in 2010 the Brazilian economy will grow by 6% or more. Inflation was already running at a 5.2% annual rate in the 12 month that ended in mid-April. That’s well above the central bank’s target inflation rate of 4.5%. Forecasts now call for inflation to climb to 5.4% by the end of 2010.

Brazil is used to high interest rates: the 8.75% Selic rate before this latest move was the lowest benchmark interest rate on record.

But in real terms—that is after subtracting the inflation rate from the interest rate—the current real interest rate of 4.3% is the third highest in the world after that in Latvia and Croatia. A real interest rate that high will attract more overseas cash to Brazil and strengthen an already strong Brazilian real. The currency gained 1.3% yesterday against the dollar and is now up 26% in the last 12 months versus the dollar. That won’t help Brazilian exports, which get more expensive every time the real appreciates against the dollar or other currencies. Among Brazil’s biggest trading partners, one, the United States, uses the dollar, and a second, China, has pegged its currency to the dollar.

How high will Brazil’s interest rates go? Last week Morgan Stanley predicted that it would take a four percentage point increase to beat back inflation. The last time the central bank raised interest rates the total increase for the cycle came to 2.5 percentage points. Yesterday’s 0.75 percentage point move looks like just a down payment.

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