Hot spots: Brazil.(INTERNATIONAL SECTION)

The country's money managers seem convinced that the recent pick-up in inflation is temporary and nothing to worry about. Since the economy is continuing to show soft spots, this means that interest rates will be cut quite a bit further. The Central Bank's assessment makes sense, but one should worry about official plans to return to the inflation indexing that in the past proved so disastrous for Brazil

In the nine months through last May, Brazil's Central Bank raised interest rates nine times in an aggressive campaign to take the wind out of the sails of inflation. This not only drove up borrowing costs for companies and consumers, it also helped spark an exchange market rally of the real which rose more than 16 percent against the U.S. dollar during 2005 and gained another 4 percent on the greenback in January. The surge dented economic growth and had painful consequences for many Brazilian exporters, but it did succeed in dampening inflation, which last year slowed to 5.7 percent (measured by the Statistics Agency's IPCA index) from 7.6 percent in 2004.

The 5.7 percent was above the Central Bank's point goal for 2005 of 5.1 percent, but it was well within the institution's broader target range of 2.6 percent-7.6 percent. It came as somewhat of a surprise for the authorities, therefore, when consumer prices according to the Getulio Vargas Foundation's IPC-S index accelerated their climb to 0.74 percent in the 30 days through January 22 from 0.49 percent in the preceding month. Some analysts took this as signaling an end to the drive for lower interest rates which the Bank has pursued since last September. In this period, the benchmark Selic rate was reduced five times. It was most recently cut on January 18, by three-quarters of a percentage point to 17.25 percent.

Banco Central, however, views January's uptick in inflation, which may well be followed by another one during February, as due, to a great extent, "to temporary factors of a predominantly seasonal nature," such as weather-related jumps in the prices of fruits and vegetables. The minutes of its policy-making group suggest that there is not much concern about a possible longer-lasting upturn in inflation. Officials at the Bank still expect IPCA inflation to ebb to 4.6 percent by the end of this year. By the same token, economic growth has sputtered in recent months and just-released official numbers say that industrial production edged up by only 0.6 percent in the year through last November.

The Central Bank predicts a real gain for the economy of 4.0 percent for 2006, following one of only about 2.5 percent in 2005. To reach this target, it will doubtlessly cut interest rates further. In fact, it will most likely increase the individual reductions, if only because under a new system adopted last October, the Central Bank will hold only eight policy meetings this year, compared to the 12 it held in 2005. The next one is scheduled for March. The authorities will not only keep interest rates on a downward track to perk up the economy ahead of presidential and congressional elections in October, they will also keep fiscal spending in high gear, even though the budget deficit (including federal and local governments and state enterprises) widened last December, to increase the red-ink spill for all of 2005 to 3.3 percent of GDP from 2.7 percent in 2004.

This is understandable, considering the electoral calendar. It should not add to ...