By Alonso Soto and Silvio Cascione
BRASILIA (Reuters) - Economists have for months clamoured for Brazilian policymakers to raise interest rates from a record low to curb soaring prices. They got their wish on Wednesday, but the central bank still has a long way to go to rebuild its inflation-fighting credentials in the eyes of the market.
After a rapid run-up in the cost of food and other staples, the central bank late Wednesday raised its benchmark Selic rate to 7.50 percent from a record low of 7.25 percent. The move, while expected, disappointed many economists because the bank flagged it would proceed cautiously with any additional hikes even after inflation pierced the official target ceiling of 6.5 percent.
"The central bank still lacks the credibility needed to convince the public that inflation will stay within the target in coming years," Carlos Thadeu de Freitas, the bank's director of monetary policy between 1986 and 1990, told Reuters.
"The bank needs to be more transparent about its inflation objectives...what inflation range they are really pursuing," he added.
Under the leadership of Alexandre Tombini, the central bank faces a tough task to balance inflation with a pressing need to revive the economy. The bank slashed its benchmark Selic rate ten straight times from August 2011 through October 2012, but prices are soaring despite two years of lacklustre growth.
Some in the market accuse Tombini of yielding to pressure from President Dilma Rousseff, who has publicly expressed a desire for low rates, despite high inflation.
Rousseff, expected to run for re-election next year, made it clear in 2011 she wanted rate cuts after a near-decade long economic boom began to flag. Earlier this week, she said her government would fight inflation "systematically", without resorting to the sky-high rates of the past. The central bank enjoys de-facto independence from the administration.
The bank will face mounting price pressure ahead of the 2014 election year, when federal and state spending traditionally becomes generous. The government has already given the green light for extra investments, proposing legislation that paves the way for more public spending by relaxing fiscal savings targets.
Other factors, including next year's football World Cup, could spur additional hikes in the cost of goods and services as half a million foreign tourists stretch Brazil's poor transport system and increase demand for services.
HIGH INFLATION HERE TO STAY?
The yield curve of Brazilian interest rate futures steepened sharply on Thursday, meaning traders don't believe the bank will curb long-term inflation. Breakeven rates, a measure of the gap between yields for fixed-rate and inflation-linked debt, signalled expectations inflation will stay above the centre of the target of 4.5 percent through at least 2022.
In its rate hike decision, the central bank clearly pointed to a modest cycle of increases ahead, warning that it will be cautious because lingering uncertainties about the health of the domestic and global economy could ease prices.
If that wasn't clear enough, two of the eight members of the bank's board voted to hold rates steady, shocking market traders who had priced a 50-basis-point hike on Wednesday.
"No one expects inflation to return to 4 percent or 4.5 percent," said Fernando Barbosa Filho, an economist with private think tank Fundacao Getulio Vargas.
The central bank, he added, appears to have "completely abandoned" its previous targets.
The bank has denied any interference from Rousseff, saying Brazil's economy is less volatile than it was in years past and the towering rates once needed to curb inflation will no longer be necessary.
Still, Rousseff's constant comments about monetary policy have complicated the bank's efforts to control inflation expectations, which influence future prices.
Price increases in recent months accelerated so much that inflation in March, at 6.59 percent, for the first time in over a year pierced a tolerance band established between 2.5 and 6.5 percent.
The rising cost of groceries and other basics has led to a public outcry. Brazil, after all, wrestled with hyperinflation as recently as two decades ago and many among the country's burgeoning consumer class worry that the economic gains of recent years could succumb to runaway price increases.
An expected drop in food prices in the second half of the year could help the central bank claim that it controlled inflation. However, the bank itself has forecast inflation will remain above 5 percent in the next two years.
While there is little real risk of inflation spinning out of control like in the past, its permanence at relatively high levels could translate into dissatisfaction at the ballot box and act as a disincentive to further economic activity.
"This hike is not enough for the bank to regain its credibility," Alexandre Schwartsman, a former central bank director and partner at Schwartsman & Associados, told Reuters. "It is just a matter of time for inflation expectations to worsen again because of the bank's lack of effort" to battle inflation.
(Editing by Paulo Prada and Andrew Hay)