Brazil slashes interest rates on global worries

BRASILIA,  (Reuters) – Brazil’s central bank slashed  its key interest rate to 12 percent from 12.5 percent yesterday 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.

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 labor market keeps  upward pressure on prices. The bank’s committee said it saw the  balance of risks for inflation as “more favorable.”

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.

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