Brazil raises rates to curb inflation

news.ft.com By Raymond Colitt in São Paulo Published: January 22 2003 19:36 | Last Updated: January 22 2003 21:30

Brazil's central bank surprised financial markets on Wednesday with an increase of its prime lending rate by 0.5 per cent to 25.5 per cent in a move to showcase tough inflation control.

It was the central bank's first interest rate decision since Luiz Inácio Lula da Silva (PT) took office as president on January 1. Most financial market analysts welcomed the move as a sign the central bank was willing to take unpopular measures to secure inflation.

The announcement did little to stem the currency on Wednesday, which fell more than 1 per cent to R$3.53 against the dollar,  due in part to ongoing fears in global markets over the threat of war in Iraq.

It is the fourth consecutive interest rate increase since October totaling 7.5 per cent and is certain to rekindle criticism by businesses fearing a further slowdown in economic activity.

Despite signs of slowing inflation, the central bank said on Wednesday, higher interest rates were required to bring price increases in line with official targets.

The rate increase came even though the central bank on Tuesday relaxed its inflation target from a maximum of 6.5 per cent to 8.5 per cent this year. In 2004 it aims for inflation to reach 5.5 per cent, compared to a target of 3.75 per cent with a margin of plus or minus 2.5 per cent.

The central bank had argued that tighter monetary policy this year would have a disproportionately negative impact on economic growth. An inflation target of 6.5 per cent, for instance, would imply a contraction of gross domestic product by 1.6 per cent.

The new inflation target, by contrast, would permit GDP growth of up to 2.8 per cent assuming equal conditions in both scenarios.