Inflation edges higher in Brazil--and government budget cuts are just the minimum expected

02/10/2011 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

In spite of a 0.5 percentage point increase in its benchmark Selic interest rate to 11.25% and an increase in bank reserve requirements in December, inflation in Brazil failed to slow in January. The IPCA index rose 0.83% for the month, increasing the annual inflation rate to 5.99%, way above the government’s target of 4.5%, give or take two percentage points. The January increase matched that of November, which was the fasted gain in prices since April 2005.

Traders are betting that the Banco Central do Brasil will raise interest rates again next month by another 0.5 percentage points to 11.75%. Brazil’s central bank, though, is counting on help from government spending cuts to stem interest rate increases below that level. According to minutes from the bank’s January meeting, the Banco Central has put government budget cuts of 70 billion reais (about $42 billion), into its policy assumptions. Economists were looking for more modest but still substantial cuts of $30 billon.

And that,$30 bilion in proposed cuts, it turns out, is what the planning ministry announced yesterday February 9. That was enough to meet expectations and interest rate futures didn't shown a big more after the announcement.  But some traders and economists lament that th government didn't use the budget announcement to send a bigger message. They're calling this a missed opportunity.

A proposed $30 billion in cuts hasn't dented the belief that rates are headed to 13% by year end. And, of course, there's still the little question of How the government will deliver on the projection.

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