Brazilian Central Bank Delivers Again

The Brazilian central bank increased the Selic benchmark rate 50 basis points to take it to 12.75 percent, underscoring the difficult environment for the Brazilian economy in 2015.

The Tightening Campaign Continues

The Brazilian central bank continued with its monetary tightening campaign in early March as it increased the Selic benchmark interest rate 50 basis points to 12.75 percent. The measure was expected, with very few analysts expecting only a 25 basis point move. This means that the central bank has increased interest rates 550 basis points since March 2013 and marks a tightening campaign that has lasted already two years. The latest increase in the Selic rate was probably a consequence of the strong, 1.24 percent increase in consumer prices in January, which took the yearover-year rate to 7.1 percent from a 6.4 percent rate at the end of 2014. This was the highest year-over-year rate since September 2011.

As we argued on a report titled “Brazil Makes an About-Face: Will It Be Enough?” in early February and available on our website, the Brazilian central bank has to deal with a very high structural rate of inflation or what is sometimes called “inflation persistence,” which makes slowing down the rate of inflation a very difficult task.

Furthermore, the Brazilian currency, the real, has been on a downward spiral since 2011 that has not abated. In early March, the real touched the 3 reais per dollar mark for the first time since 2004, which will put even more pressure on the Brazilian central bank to bring inflation down to its target of 4.5 percent plus or minus 2 percentage points. But the biggest problem the central bank and the Dilma administration are facing is that it is clear that the recent increase in inflation has nothing to do with stronger economic growth. Rather, the current increase in inflation has been triggered by the depreciation of the currency and a resetting of inflationary expectations at a time when the economy is suffering stagnation. That is, today’s Brazilian economy is suffering from what has been called “stagflation,” a combination of high inflation and either stagnant or even negative economic growth.

The Original “Volcker Rule”

The prospects for monetary policy in Brazil will not remain supportive of economic growth. The reason for this is that the Brazilian central bank knows very well that the only way to beat stagflation is by increasing interest rates even in the face of a stagnant or even recessionary economy. This is what we could call the “original” Volcker Rule. That is, stagflation is beaten by increasing interest rates until inflationary expectations are brought back under control. Thus, we should not expect any letting go from the Brazilian central bank in terms of interest rates during this year, especially as the U.S. Federal Reserve starts normalizing its own monetary policy by mid-year, with Brazilian interest rates still expected to continue to go up from the current 12.75 percent level.