Brazil central bank president Alexandre Tombini will need nerves of steel over the next few months.

Inflation – the sworn enemy of Brazilians who suffered more than their share of it during past decades – is rearing its ugly head again. September inflation came in at 7.31 per cent compared with a year earlier, the highest in six years.

“Inflation targeting is dead,” Bloomberg quoted Edwin Gutierrez of Aberdeen Asset Management as saying.

The central bank continues to insist that inflation targeting is, in fact, as alive and well as it has ever been. What has changed is the global economic outlook. This has deteriorated so much, according to Mr Tombini and his monetary policy committee, that it justified the central bank’s surprise 50 basis point interest rate cut in August. That cut abruptly ended a tightening cycle that had lasted much of this year.

Some economists argue the lag effect from changes in interest rates in Brazil is such that a pre-emptive move was justified in this case. But the central bank faces a communications problem. Cutting rates without warning at a time of high inflation sends a mixed signal to the market about where the bank’s priorities lie – with controlling prices or with the politically sensitive issue of maintaining economic growth.

Indeed, if inflation ends the year at above the central bank’s target of 4.5 per cent plus or minus 2 percentage points, Mr Tombini will have a big public relations exercise on his hands. He will be required to write an open letter to explain why inflation exceeded the target.

Where inflation ends the year is going to be a close call. Many market economists are predicting prices will register a 6.5 per cent increase on the dot for full-year 2011. Says Goldman Sachs in an analyst note:

“For the year as a whole, we expect IPCA inflation to slide to 6.5 per cent (year-on-year), under the assumption that the high base from 2010 will reduce the year-on-year rates. The main immediate risk to this forecast is an increase in tradable goods prices resulting from the weaker BRL [Brazilian real versus the dollar].”

Mr Tombini and the central bank have taken a punt on the global economic outlook. Now they must weather the next few months of high inflation while they wait to see whether their calculations were right.

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Brazil braces for manufacturing contraction, FT

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