Deepening Brazil recession puts interest rate hike in doubt

Thursday, 21 January 2016 00:00 - - {{hitsCtrl.values.hits}}

BRASILIA (Reuters): Growing fears about Brazil’s deepest recession in decades could prompt the central bank on Wednesday to keep interest rates on hold or opt for a smaller increase than previously signalled, analysts say.

Many economists changed their forecasts to a 25-basis-points rate increase from 50 basis points after Central Bank Chief Alexandre Tombini said on Tuesday that a “substantial” cut in Brazil’s growth outlook by the International Monetary Fund will be considered in the rate decision. Tombini’s unusual statement was interpreted by many as a signal the central bank was bowing to political pressure to limit future rate hikes to avoid exacerbating an economy expected to shrink nearly 8% between 2015 and 2016. Despite the grave recession, the central bank had clearly signalled that higher borrowing costs were needed to curb inflation that hit 12-year highs above 10% in 2015.

However, falling commodity prices, a slowing Chinese economy and political dysfunction in Brasilia has added to fears of Brazil’s recession stretching into 2017, raising doubts about a rate hike.

Economists are closely divided between those who believe the bank will keep a tough stance with a 50-basis-point rate hike and others who predict a smaller increase or no hike at all, a Reuters poll of economist showed on Tuesday. A week ago a wide majority expected a steep rate hike.

“Given the intensifying political pressure on the central bank ... we do not rule out that an eventual resumption of the hiking cycle starts with a more moderate 25 basis points,” Alberto Ramos, senior economist with Goldman Sachs said on Tuesday. “But that would likely be interpreted as a somewhat weak monetary signal, in response to the current inflation challenge.”

Officials in President Dilma Rousseff’s administration have expressed fears that more rate hikes could foil plans to revive the economy through fresh credit from public banks.

Private economists concede that an interest rate hike now will do little to tamper inflation expectations, given a weakening currency and steep hike in bus fares nationwide. However, a decision that contradicts previous guidance could jeopardise the bank’s inflation-fighting credentials.

“The credibility of the central bank, already in question, will be harmed if policymakers go for a smaller rate hike,” said Luciano Rostagno, chief strategist with Mizuho Bank. “That decision could push up inflation expectations and ignite market volatility.”