Brazil’s central bank on Wednesday night increased interest rates - to 13.75 per cent, up from 13 per cent - after the country reported stronger-than-expected growth in the second quarter. The move put rates at their highest level in nearly two years.

The government appeared to be delighted with the growth figures, which exceeded most analysts’ expectations. Gross domestic product surged by 6.1 per cent compared with the second quarter of 2007 and by 1.6 per cent compared with the first quarter this year.

But the data will have added to fears that the economy may be overheating.

The central bank had raised its target overnight rate from 11.25 per cent a year in March to 13 per cent ahead of Wednesday’s meeting, and 28 out of 29 economists polled by Bloomberg had predicted Wednesday night’s 0.75 percentage point increase in rates.

“This is the worst of worlds for the central bank,” said Sérgio Vale at MB Associados in São Paulo. “Domestic demand [consumption plus investment] is 8.7 per cent higher over the past 12 months. That’s double the rate of demand during the last boom in growth during 2004.”

Consumption in Brazil has been posting high rates of growth for several quarters as the economy has enjoyed the effects of several years of stability and, until recently, benign international conditions, especially in strong global demand for Brazilian exports. Rising wages, substantial job creation and wider access to cheaper credit have fuelled demand, leading to a surge in spending on big ticket items such as housing and cars.

Yet faster growth has also stoked inflation. The central bank’s regular survey of market economists shows that, while inflation expectations for this year have fallen slightly, from 6.32 per cent last week to 6.27 per cent this week, they are still well above the government’s target of 4.5 per cent.

Marcela Prada, economist at Tendências Consultoria in São Paulo, said that the data underlined the strength of gross domestic product growth in Brazil. “The figures were stronger than expected but this really is the scenario,” she said.

But Mr Vale said the central bank would be especially concerned at high rates of growth in government spending. Growth in consumption by federal, state and municipal governments stood at 5.3 per cent in the second quarter, well above rates of between 2 per cent and 3 per cent common until last year. Part of the increase was explained by town halls spending before municipal elections next month, but the increase was much greater than usual.

“The government sees public spending as a contributor to growth and therefore a good thing, in good times and in bad times,” he said.

Many economists have expressed concern at the government’s pro-cyclical fiscal policy, in which it has increased expenditure in line with bigger tax revenues resulting from faster growth.

Henrique Meirelles, president of the central bank, said he would like “a little more help” from fiscal policy in fighting inflation.

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