Wednesday, 27 April 2011

A soaring currency is complicating the battle against inflation.

Wild horses.



Apr 20th 2011.




INFLATION is at 6.3% and is supposed to break through the ceiling of the Central Bank’s target of 2.5-6.5% for the first time since it was adopted in 2006. That is despite the currency surging to 1.58 reais to the dollar, close to its peak since it was allowed to float in 1999—and much stronger than either the government or industry would like. All this means that monetary policy in Brazil is trying to tame two wild horses at the same time. The Central Bank has already raised its benchmark rate by three percentage points over the past year, to 11.75%, with another 0.25-0.50 points expected from its monetary-policy committee on April 20th. But as the bank admitted in its latest quarterly inflation report, it does not now expect to bring inflation back to its central 4.5% target by the end of 2011. The economic cost, it said, would be “too high”.




The difficulty for the Central Bank is that each rise in interest rates—already the highest of any big economy—makes Brazil more attractive to foreign capital. In the first three months of 2011 it saw net inflows of $35 billion, more than in the whole of 2010. That pushes up the currency, which is not directly the monetary-policy committee’s concern, and throws fuel on an overheated economy.


To try to tame inflation without boosting the real further, the bank is resorting to what central bankers call “macroprudential measures”, such as higher bank reserve-requirements. The finance ministry has done so by raising taxes on consumer credit, foreign bond issues, and on overseas loans and derivatives’ margins. Without such measures, says the finance minister, Guido Mantega, the real would be at 1.4 to the dollar.


Some think the government should welcome the inflows, let the real rise where it will and cut public spending to eliminate the expansionary fiscal deficit. FIESP, an industrialists’ trade body in São Paulo, says its members are already struggling: in 2010 the share of imported industrial goods in total consumption was at an all-time high. It wants the government to restrain speculative inflows by imposing far higher initial margin requirements on currency futures.


Dilma Rousseff, the president, has promised to do whatever it takes to control inflation.

http://www.economist.com/node/18587335
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