Brazil halts interest rate hikes as recession takes hold

A man walks past the stock quotation board on the floor of Brazil's BM&F Bovespa Stock Market in Sao Paulo.
A man walks past the stock quotation board on the floor of Brazil's BM&F Bovespa Stock Market in Sao Paulo.PHOTO: REUTERS

BRASILIA (REUTERS) - Brazil's central bank halted one of the world's most aggressive rate-hiking cycles on Wednesday (Sept 2), taking pressure off an economy struggling with recession despite concerns that a budget crisis could stoke inflation.

In a unanimous vote, the central bank's monetary policy committee, known as Copom, kept its benchmark Selic rate at 14.25 per cent, a nine-year high and still the highest among the world's top 10 economies. An overwhelming majority of economists expected policymakers to keep interest rates unchanged after seven consecutive hikes.

While most other major emerging-market economies are gearing up to raise borrowing costs to head off rising prices, Brazil is ending monetary tightening as its economic downturn proves more severe than even the most pessimistic economists had envisioned.

The bank made no changes to its decision statement, signaling again that it will hold borrowing costs where they are for some time to bring inflation back to the 4.5 per cent center of the official target.

The recession and a decline in inflation expectations prompted the central bank to end the tightening cycle even though inflation remains near double digits, climbing to 9.57 per cent in mid-August.

Although recession is helping slow inflation as consumption drops, renewed political turmoil has weakened the real and is keeping the central bank under pressure.

"The exchange rate has been weakening significantly, dragged down by domestic and external uncertainties ... that could warrant an additional rate hike," said Ilan Goldfajn, chief economist with Itau Unibanco.

President Dilma Rousseff's inability to halt the deterioration of the government's finances is threatening Brazil's investment-grade rating and rattling local markets.

The leftist leader, whose approval rating is at an all-time low, is facing growing resistance to her fiscal austerity drive and the threat of impeachment by her opponents in Congress.

The fiscal crunch and growing fears of a sustained Chinese economic slowdown have weighed on the real, which has slid nearly 30 per cent so far this year to its weakest in nearly 13 years. A weaker real fuels inflation by making imports more expensive.

The central bank has warned that it will act decisively to prevent consumer price growth from deviating significantly from the government's target.

However, a deepening recession could force policymakers to start cutting rates next year, some economists say.

The economy contracted a worse-than-expected 1.9 per cent in the second quarter, sinking into what is predicted to be its deepest recession in 25 years.