Inflation is at 6.3% and is poised 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 attempting 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 as The Economist went to press. 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 footloose 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, which is.
To try to curb 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 chipped in 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. All that would bear down on inflation and in turn allow the bank to cut rates, thereby stemming inflows and eventually allowing the currency to fall. But the government is afraid this would lead to a destabilising outflow once rich countries start tightening monetary policy—and that manufacturers would be unable to survive a stronger real, even temporarily. 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. A big test involves the minimum wage, due to rise next year by 7.5% above inflation, unless the government amends the formula used to calculate it. That would push up state pensions, which are linked to minimum pay, as well as wages across the board, as many salaries are expressed in multiples of the minimum. The danger in trying to steer the exchange rate and inflation simultaneously is the risk of losing control of both of them.