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Higher Rates Add To Headwinds For Brazilian Economy: Capital Economics

7/11/2013 9:24 AM ET

The hawkish stance of the Brazil Central Bank, which signaled further monetary tightening after raising it policy rate at the latest meeting, indicates that the economy will continue to struggle in the long term, Capital Economics Chief Emerging Markets Economist Neil Shearing said.

According to the economist, by hiking the interest rate the central bank has underestimated the extent of the crisis the economy is facing and the rising inflation pressures.

Shearing noted that the recent fall in the Brazilian 'real' is not necessarily a major threat to the inflation outlook, and the weakness of the currency may not be a big concern for policymakers.

However, any intervention by the bank to guard the currency against a disorderly fall by a renewed heavy sell-off would pose a significant upside risk to interest rates.

Further, the firm observed that Brazil's food inflation, which has accounted for around three-quarters of the rise in headline inflation over the past year, may now be starting to unwind. This would more than offset any upward pressure on inflation from a weaker real.

Capital Economics expects Brazil's inflation to fall to 5.5 percent by the start of 2014 from 6.7 percent in June.

The central bank raised its benchmark interest by 50 basis points as expected to 8.5 percent in the latest rate-setting session.

In its statement, the bank hinted at further rate hikes, most probably in August and October, which will see the rate rising to 9.25 percent at the end of the year and 11 percent by the end of 2014. The rate has been raised by a cumulative of 125 basis points since April.

by RTT Staff Writer

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