Brazil’s central bank chief Alexandre Tombini has made no secret of his expectation that the benchmark Selic interest rate will hit single digits this year.
The theory is simple: Brazil will have its cake and eat it too. Not only will the Selic, which was as high as 12.5 per cent and is now 10.5 per cent, fall to as low as around 9 per cent (according to some estimates), but Tombini will oversee a fall in inflation this year to the mid-point of the target of 4.5 per cent plus or minus 2 percentage points.
The rationale for all of this is that the weaker global economic outlook and softer domestic activity are providing the circumstances for a fall in interest rates that will not stoke inflation.
The problem is the market does not believe Tombini.
A central bank survey of economists on Monday gave a record-high advance prediction for inflation, forecasting it would hit 5.11 per cent in 2013, well above the mid-point of the target. Normally, these surveys give the central bank the benefit of the doubt and forecast something close to the mid-point.
This caused considerable unrest in some areas of the market on Monday. This from Bloomberg:
PDG Realty SA Empreendimentos e Participacoes SA, Brazil’s biggest homebuilder by revenue, dropped to a one-month low as it led a rout in real-estate stocks after economists raised their 2013 inflation forecast to the highest on record.
PDG lost 3.2 percent to 7.22 reais at the close of trading in Sao Paulo. The benchmark Bovespa dropped 1.1 percent. The BM&F Bovespa Real Estate index fell 1.2 percent, with 14 of 21 members declining.
Homebuilders dropped as economists increased their 2013 inflation forecast to the highest on record. Consumer prices in Brazil will rise 5.11 percent next year, according to the median forecast in a central bank survey of about 100 economists published today, up from last week’s estimate of 5.02 percent. The yield on the Brazilian interest-rate futures contract due in January 2013 rose six basis points, or 0.06 percentage point, to 9.33 percent.
The central bank has been unable to dispel suspicions that its enthusiasm for a single-digit rate is politically motivated. President Dilma Rousseff is an advocate of lower rates, which would help stimulate a long-term lending market in Brazil and in turn foster the development of infrastructure.
These are all things the country sorely needs. But you cannot merely wish them into existence. Doggedly pursuing lower interest rates at any cost could spark a return of inflation. A rapid and sustainable fall in inflation and therefore rates can only be achieved through structural reforms, such as lowering the tax burden, reducing government spending as a percentage of gross domestic product and improving the cost of doing business.
Otherwise, Brazil will just get back on the old seesaw of rapid cooling followed by rapid over-heating. At least one research house, Capital Economics, is already sounding an early warning cry on the potential return of that old symptom of over-heating, credit growth.
Having shown signs of slowing in the second half of last year, Brazilian credit growth appears to have picked up again in recent months. But while this should give a boost to overall GDP growth in the first quarter of this year, the bigger picture is that the pace of lending growth seen over the past couple of years has been unsustainable. A further rapid expansion in bank lending from here on would be a major concern and is something that merits close attention over the next 6-12m.
It seems a bit soon to be worrying about this yet but if interest rates are allowed to fall too low too quickly, everything else in Brazil, especially inflation, will rise – and fast.
Brazil’s interest rates: single digits?, beyondbrics
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