Brazil raises rates to fight 'virus of inflation'

news.ft.com By Raymond Colitt in São Paulo Published: February 20 2003 4:00 | Last Updated: February 20 2003 4:00

Brazil's central bank yes-terday raised interest rates for the second time in a month to curb what new President Luiz Inácio Lula da Silva described this week as the "virus of inflation".

While the move was applauded in the financial markets, industry leaders said high interest rates were choking the economy and failing to curb inflation.

The rise in the central bank's prime lending rate by 1 percentage point to 26.5 per cent underlines the challenges facing Mr Lula da Silva, whose economic policies have already come under attack from leftwingers in his Workers' party.

In a further tightening of monetary policy, the central bank also raised commercial banks' mandatory reserves on short-term deposits from 45 per cent to 60 per cent.

Earlier this week Mr Lula da Silva defended the government's fiscal and monetary austerity in light of the threat of war in Iraq. "We are facing difficult times ahead. The world has entered into a period of increased uncertainty."

The fear of higher oil prices and reduced lending to emerging markets as a result of a military conflict has already renewed pressure on the Brazilian currency and could bring more domestic fuel price rises.

The inflation bubble resulting from last year's 40 per cent currency depreciation has lasted longer than many analysts expected. Financial institutions expect it this year to reach 12 per cent, well above the government's target of 8.5 per cent.

"The currency's stability is threatened. The virus of inflation is again a real threat to Brazil's economy," Mr Lula da Silva said this week in a surprisingly blunt acknowledgement of the economic challenges he faces.

Unionists and leftwing radicals within the Workers' party criticised last month's interest rate rise as well as this month's big budget cuts, designed to guarantee debt payments. Rates have risen 8.5 points since October.

Most banks had expected an increase of 0.5-1.5 per cent. The announcement was delayed by several hours, which analysts interpreted as a sign of intense debate within the monetary policy committee.

The decision was closely watched as a test of the central bank's commitment to strict monetary policy as Mr Lula da Silva's economic austerity came under fire.