Central Bank May be Forced to Reverse Course

The latest inflation report from Brazil’s central bank, Banco Central do Brasil, sets out in unprecedented detail what appears to be the government's emerging, new macroeconomic policy framework, according to the Economist Intelligence Unit.

Aiming to provide a supportive environment for Brazil’s emerging competitiveness agenda, the BCB strongly suggested it will be possible to maintain lower benchmark rates for a prolonged period, that reducing taxes and energy tariffs will help cut domestic inflation and that the country’s "neutral" interest rate has permanently fallen.

But there are "considerable" risks to this position, the EIU said in a recent report. In particular, the 2013 outlook "may be less benign on the inflationary front than the BCB currently believes."

If that’s the case, "the BCB will have to reverse its stance and raise rates next year, which would certainly compromise some of the newly acquired fiscal space," the EIU said. This, in turn, would prevent the government from undertaking its aggressive tax reduction plans and the pro-growth competitiveness agenda.

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