Brazil slashes interest rates on global worries

BRASILIA Thu Sep 1, 2011 8:19am IST

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BRASILIA (Reuters) - Brazil's central bank slashed its key interest rate to 12 percent from 12.5 percent on Wednesday in a shock decision that it said reflects a mounting global slowdown as well as weaker growth in Latin America's largest economy.

The sharp 50-basis-point cut risks fanning investor worries about stubborn inflation and reviving concern about government influence in monetary policy after a series of comments by senior officials pushing for a rate cut in recent days.

In a split decision, the central bank's monetary policy committee, Copom, voted five to two to trim the so-called Selic rate by 50 basis points, following five consecutive increases earlier this year. It is Brazil's first rate cut since July 2009.

Explaining its decision, the committee said it saw a "substantial deterioration" in the international outlook as the United States and Europe struggle with debt and anemic economic growth. It said the slowdown in developed economies was likely to be more prolonged than previously expected and could hit Brazil's economy through weaker trade and investment flows and tighter credit.

All 20 analysts in a Reuters survey had expected the central bank to keep the Selic rate unchanged. The decision also surprised investors -- interest rate futures had been reflecting expectations of steady rates or at most a cut of 25 basis points.

"I think it's a huge mistake. They gave in to political pressure," said Tony Volpon, economist and Latin America strategist at Nomura Securities in New York.

"The central bank is making a bet that it is 2008 all over again but central banks shouldn't be in the business of making bets," he added, referring to the 2008 financial crisis.

Clear signs of an economic slowdown have emerged in the past few weeks as Brazil feels the impact of global financial problems in addition to a natural cooling from unsustainably strong growth of 7.5 percent last year.

CONCERN OVER INFLATION, SPENDING

Economists have been cutting their GDP forecasts for the year to between 3 and 4 percent as evidence builds that Brazil's indebted consumers are running out of steam and the manufacturing sector suffers from a strong currency.

Industry groups cheered the decision. Fiesp, Brazil's most influential business lobby, called the bank's move an important step to prevent the economy from being contaminated by the global turmoil.

Most analysts had believed the central bank would be too wary of lingering inflation pressures to cut rates this soon, even by 25 basis points.

"I found the decision a bit premature," said Mauricio Rosal, chief economist at Raymond James in Sao Paulo, who was expecting only a 25 basis point cut by the end of 2011.

"...From now on, the Selic rate will become a much more difficult policy instrument to predict, and a volatile one."

Brazil's cut signals a rapid shift in interest rate expectations as Latin America responds to a darkening global outlook. Since the start of the month, markets have swung from expecting hikes to pricing but now see policy loosening in Brazil, Chile and Mexico, where the central bank stunned markets on Friday by opening the door to rate cuts.

The hefty rate cut in Brazil could raise market nerves about a lack of inflation control as a hot labour market keeps upward pressure on prices. The bank's committee said it saw the balance of risks for inflation as "more favourable."

The decision is likely to spark volatility in local interest rate markets, given conflicting signals as the government aims to prevent a broad economic slowdown while keeping control of inflation that is running above 7 percent annually. Some analysts are concerned that the boldness of the central bank move will not be accompanied by enough public spending restraint.

The central bank, which government officials says has full control when it chooses to cut rates, has come under pressure to ease policy following a series of government comments on the need to cut rates sooner or later.

President Dilma Rousseff's government said this week it would maintain spending discipline for the rest of 2011, hoping to reduce demand pressures in the economy and pave the way for a cut in interest rates that are among the world's highest.

Since taking office in January, Central Bank President Alexandre Tombini has defended a gradualist policy approach that involves closer policy coordination with finance ministry officials.

(Additional reporting by Guillermo Parrabernal, Jeb Blount and Brad Haynes; writing by Stuart Grudgings; Editing by Bernard Orr)

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