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By Alonso Soto and Carl Patchen
BRASILIA (Reuters) - Monetary policy will help mitigate the impact a weaker local currency could have on inflation in Brazil, central bank chief Alexandre Tombini said on Tuesday.
Tombini spoke after Brazil's currency, the real, touched its weakest level in four years in intra-day trading on Tuesday, which prompted the central bank to intervene twice in the forex market. The real closed 0.55 percent weaker at 2.1775 per U.S. dollar.
"A way to allow the exchange rate to evolve without creating (market) distortions is to have an adequate monetary policy," Tombini told a congressional committee in Brasilia, stressing that a flexible exchange rate regime also limits the currency's impact on prices.
The sharp depreciation of the real has raised fears of higher inflation ahead as authorities struggle to contain a surge in the price of services and some food items. A weaker real makes imported goods more expensive.
Higher interest rates, in theory, should bring more U.S. dollars into the Brazilian economy as investors seek to put their money into assets that offer better returns. The Brazilian government has removed a series of capital controls to facilitate the flow of greenbacks.
Expectations that the United States will taper its bond-buying program have weakened the real and other emerging market currencies. The real has lost more than 9 percent of its value against the dollar in the last three months, the most among the 36 major currencies tracked by Thomson Reuters.
Tombini said that the prospects for a recovery in Brazil will help lure large inflows of foreign capital even as the world braces for a withdrawal of U.S. stimulus.
Under Tombini the central bank started to hike interest rates in April, accelerating the pace of tightening at its last meeting to contain a rise in inflation expectations that threatened to damage an already weak economic recovery.
Alfredo Coutino, Latin America director for Moody's Analytics, said the central bank "will not be restrained" in using its U.S. dollar reserves to prevent a sharp depreciation of the real. The bank currently holds $376.3 billion in foreign reserves.
Tombini reiterated that the central bank will not hesitate to reduce "excessive" volatility in the forex market.
The yields on Brazilian interest rate futures rose sharply across the board on Tuesday, signaling traders are expecting more aggressive rate hikes ahead. The yield curve prices in a rate hike of 75 basis points to 8.75 percent at the bank's next rate-setting meeting on July 10, according to Thomson Reuters calculations.
(Additional reporting by Luciana Otoni; Writing by Alonso Soto; Editing by Chizu Nomiyama and Leslie Gevirtz)