beyondbrics

Alexandre Tombini, president of Brazil’s central bank, has mounted a media campaign in recent days to counter criticism over a surprise decision on the last day of August to cut the benchmark Selic interest rate. Last week, he appeared on Globo television and on Monday morning in the Valor Econômico business newspaper making the argument for the cut.

In spite of the suddenness of the decision – the 50-basis point cut came without any pause after consistent increases in rates this year – he insisted the central bank’s target remained inflation and only inflation.

The cut was necessary because of the deteriorating global outlook. Inflation would still converge towards the middle of the official target of 4.5 per cent plus or minus 2 percentage points next year, he said. This was in spite of its reaching a six-year high in the 12 months to end-August of 7.23 per cent.

He does not seem to have convinced some economists, who believe the decision is at least partly politically motivated. The government wants to lower interest rates to shore up economic growth and to prevent further appreciation of Brazil’s currency, the real, against the US dollar.

If Brazil can continue to grow above 3 per cent, the good times – record low unemployment and all the positives that come with it – will continue. What’s not to like about that? Nothing, except that it could result in inflation remaining above target for some time to come, economists believe.

The central bank’s survey of 100 economists who cover Brazil found the following (as reported by Bloomberg):

Analysts covering the Brazilian economy raised their 2012 and 2013 inflation forecasts for a second straight week, in the expectation that the central bank will continue to lower interest rates this year.

Consumer prices will rise 5.40 per cent next year and 4.80 per cent in 2013, according to the median forecast in a Sept 9 central bank survey of about 100 economists published on Monday. The forecasts were up from 5.32 per cent and 4.6 per cent respectively the previous week.

The central bank will cut borrowing costs a half point at each of its two remaining policy meetings this year, the survey found.

Economists expect the benchmark Selic to end this year at 11 per cent, and cut their forecast for the 2012 year end Selic to 11 per cent, from 11.88 per cent.

“Market economists still have a lot of resistance to buying the central bank’s scenario that the crisis in Europe can bring down commodities prices enough,” said Andre Perfeito, chief economist at Sao Paulo-based Gradual Investimentos. “Domestic demand is much more important for inflation right now than outside factors.”

And, still from Bloomberg:

The economists cut their estimate for this year’s economic growth for a sixth straight week, to 3.56 per cent from 3.67 per cent a week earlier. The economists also cut their 2012 growth forecast to 3.80 per cent, from 3.84 percent.

It seems that even with lower interest rates, economists believe the outlook for growth is weaker. Indeed, if the global slowdown proves to be deeper and longer than markets are anticipating, Tombini’s decision to begin cutting now may look smart. The Brazilian economy is a supertanker that turns slowly. Interest rate changes carry a lag time of six to nine months, which is exactly when the economy might need some support if a more severe version of the slowdown does play out.

But the central bank must weigh against this the cost to its credibility in the market of making sudden changes. Only time will tell if the trade-off was a good one.

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