Brazil’s battle against inflation

By 20 June, 2011

Brazil’s central bank is desperately trying to grasp the reins of inflation. The central bank’s chief, Alexandre Tombini, will certainly hope that inflation continues on its current course and falls within the central bank’s target by the end of 2011. If inflation is above the Bank’s target (4.5%) by more than two percentage points in December, by law, he will have to swallow his pride and write an open letter explaining himself to the finance minister.

However, there are tentative signs from recent data that Brazil’s central bank is making some headway. Although annual inflation rates in Brazil reached 6.55% in May 2011 and are forecast to hit 7% by August, month-on-month rates show that price rises have started to slow.

The central bank has already raised interest rates by 1.5 percentage points this year, reaching 12.25% in June. So far, the strategy has been to use low incremental rate rises rather than making a one-off move designed to demonstrate intent. However, in recent weeks (in response to market scepticism) some important government officials, including President Dilma Rousseff, have voiced their concern about inflation and their determination to fight it. Markets are expecting a further rise in interest rates in July.

Alexandre Tombini also introduced limits on how much banks could lend out, much like policy measures taken by China.

Dilma Rousseff also announced further measures to combat inflation in the way of a 50 billion real ($31.5bn) reduction in public spending. In a recent speech she acknowledged that parts of the economy were significantly overheating, particularly the real estate sector and that the government had a significant challenge to turn this year’s expected 4% growth into a sustainable path. In 2010, Brazil’s economic growth reached 7.5%.

It is unlikely that the government will abandon their tighter monetary and fiscal policies any time soon. Minutes from the central bank published this week reiterated it would maintain its current monetary policy adjustment for a “sufficiently prolonged period.”

In combination the measure appear to be having an impact as consumers and factories responded to tighter credit, easing worries about the economy overheating. Retail sales data showed an unexpected slowdown of 0.2% in April 2011 from March, the first decline in a year. Data on industrial production in some sectors of the economy also showed signs of slowing.

It confirmed signs of an underlying slowdown in the growth of Latin America’s largest economy, following the government’s push to bring back inflation within its target level and tackle the potential of emerging credit bubbles.

Rising consumer prices have become a major focus for Brazil and other emerging markets, including China and India, as those countries struggle to contain the inflationary pressure that accompanies rapid economic growth even as much of the developed world continues to struggle.

But with the global economy showing signs of slowing and commodity prices dipping, Brazil’s policymakers have a difficult task of judging how much strength to add to the brakes.

It’s clear that there is no easy solution and Brazil is caught between a rock and a hard place. If they continue to tighten monetary policy they could slow economic growth to a point that is politically unacceptable. But perhaps even more dangerous is inaction, where basic items such as food become unaffordable.

For Brazil, the global economic slowdown may be arriving at the right time. Mexico, Peru and Colombia have all tightened monetary policy this year and slowing activity in China, the regions largest market, may also help cool rising prices. The drop off in global demand will help ease demand-push inflation and with previous policy measure taken, the signs are that inflation is heading in the right direction.

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