The Brazilian central banks nearly year-long monetary policy tightening drive is finally bearing fruit. The monetary policy committee (Copom) hiked the benchmark Selic interest rate by 375 basis points since last September in a move to curb inflation. Monthly inflation duly fell and in May was down to 0.49%well below initial expectations of as much as 0.58%.
Easing inflation led Copom to keep interest rates unchanged in June, though at a 20-month high of 19.75%. The government, which maintains its 5.1% inflation target for 2005 and 4.5% for 2006, announced in June that the target would remain steady at 4.5% for 2007. Economists feel inflation will end this year closer to 6%, which is still within the central banks tolerance margin of up to 6.5%.
Concerns remain that continuing high interest rates will dampen economic growth, as economists revised 2005 GDP forecasts to 2.8% from 3.7%. With the average rate on consumer loans rising to a 17-month high of 65.7% in May (33.7% average rate on corporate loans), bank lending grew by only 0.5% in May, which represents a 16-month low. Authorities counter that suspending rate increases will help fuel growth by year-end.
A mounting political scandal could, however, revive the inflation bogey. Cabinet chief Jos Dirceu, a close ally of President Luiz Incio Lula da Silva, resigned in June amid charges that he was aware of alleged ruling Workers Party bribes to legislators in exchange for congressional support. The scandal also includes allegations of corruption at state-owned companies, leading to a series of high-level inquiries.
Lula supports the investigations and has promised a package of anti-corruption reforms, and authorities contend the situation will not affect economic growth prospects. Political problems are resolved in the political arena, and economic problems are resolved in the economic arena, says finance minister Antonio Palocci. Economists, however, are monitoring the scandal for signs of a potential crisis.