8:14 pm
Mar 12, 2014

Inflation in Brazil accelerated in February, and there may be more to come.

One of the worst droughts in 40 years could be changing the game for the Central Bank of Brazil, suggesting interest rates could be pushed up even higher than investors are currently expecting.

After a sharp decline in January, inflation in surged in February, largely due to one-off annual increases in tuition fees. The IPCA consumer price inflation in February was 0.69%, slightly higher than had been expected; 12-month rolling inflation reached 5.68% in February, up from 5.59% in January. And well above the target of 4.5%.

The central bank had been relying on inflation to decelerate in the first half of this year, but that now seems unlikely. Food prices have jumped sharply in recent weeks and could remain high for the next couple of months.

Underlying inflation pressures remain significant. Even if there were to be some decline in services inflation due to slower consumer spending, the government would likely use that space to allow the prices of some managed items, such as electricity and gasoline, to recover. They’ve been kept artificially low in recent months to help with inflation.

While the food-price shock should only be temporary, it means the respite the central bank had expected in the first six months likely won’t materialize. That in turn may prevent the central bank from bringing to an end its year-long cycle of raising its key interest rate.

“The bad news is that we’re going to cross the upper ceiling of the band,” said David Beker, an economist at Bank of America Merrill Lynch in Sao Paulo. “It’s a shock they can’t control.”

For now, Mr. Beker still expects the central bank to wrap up the rate hikes at the next meeting on April 1 and 2. But he says that there’s a growing risk they won’t be able to stop.

The central bank increased the Selic to 10.75% at its last meeting in February. The rate has risen by 3.5 percentage points since it began raising the rate in April 2013.

Opinions at the moment seem to be divided between a pause at the next meeting, or another 0.25 percentage point increase. But some are starting to factor in the possibility that interest rates may be raised higher for longer.

Higher interest rates is likely to be bad news for economic growth, which is already underperforming. Economists see growth declining this year to around 1.7%, from a still-low 2.3% in 2013.

Adding to the central bank’s problems is the political scenario, given the October presidential election. Analysts say the institution may come under political pressure to stop raising interest rates despite high inflation to avoid choking off economic growth.