Brazil's economy slows but bets are that interest rate increases aren't done

02/03/2011 6:13 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Will a second straight monthly drop in industrial production put Brazil’s interest rate increases on hold?

December output fell by 0.7% from November. November’s output was itself down 0.2% from October. The drop came as a surprise to economists who were expecting output to rise by 0.9% in December, according to Bloomberg. Industrial output was still up 2.7% from December 2009.

The futures market fell as traders saw the data as an indication that the economy is slowing, but futures prices still show that traders except the central bank, the Banco Central do Brasil, to raise the benchmark Selic interest rate another 0.5 percentage points to 11.75% in March.

The blame for the drop in production gets placed on the doorstep of an over-valued real. The 50% appreciation in Brazil’s currency over the last two years has made imported goods—especially from China—really cheap. And that’s led to declines in sales and production by domestic Brazilian producers.

Another increase in interest rates would increase cash flows into Brazilian assets driving the real up further. But traders are betting that the central bank doesn’t have any choice in the short-term. Inflation in Brazil accelerated to an annual rate of 6.04% in January. The central bank’s target for inflation is 4.5%.

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