The Brazilian central bank has revised the country’s key interest rate to 11.75% in an effort to control raging inflation in one of the world’s fastest growing economies.
This is the second time the central bank raised interest rate by 50 basis points this year. The last time it had raised the key interest rate to 11.25%.
The current hike is also the second time after the country’s new President Dilma Rousseff and central bank chief Alexandre Tombini took office.
Inflation for 2010 was recorded at 5.91% last year and is expected to remain over 5% in the current fiscal. Brazilian industrial production expanded moderately by 0.2% in January over the previous month, latest data indicates.
The new factory output data is a welcome relief as consensus forecast had pegged the production to decline by 0.7 percent in January after December’s number had showed a dip of 0.8 percent.
The high domestic interest rate risks attracting excessive foreign capitals, thus strengthening an already overvalued Brazilian Real.
Record low interest rates in more developed economies have already driven investors to emerging economies like Brazil, which offer superior returns.
A strong domestic currency hurts exports since they become more expensive and thus less competitive.
Neil Shearing – Senior Emerging Markets Economist at Capital economics said: “Despite the improving picture for industry in the very latest data, the bigger picture is that manufacturers are still struggling to live with the effects of a stronger currency”.
To reign in spiraling inflation, the government had announced last month spending cuts amounting to 50 billion Reais (£19 billion, $30 billion).
However, economists argue that Brazil should try to slow down the fast expansion of consumer credit that has fueled the consumption boom.
A further fiscal tightening would ensure a more balanced growth, Mr. Shearing argued. “This, in turn, will require a radical, and politically very difficult, overhaul of the public finances that goes well beyond the 50 billion Reais of spending cuts that were recently announced”, he added.
Latin America’s largest economy had grown by more than 7% in 2010 and is expected to grow at about 5% in the current fiscal.
The central bank has already increased the reserve ratio of the country’s banks so that less money is available for lending.