When Brazilian interest rates nose-dived to record lows last year, President Dilma Rousseff and many economists here boasted that the days of sky-high borrowing costs were over.
They may have been wrong.
Heavy public spending, a sharp depreciation of the local currency and an expected normalization of monetary conditions in the United States could force Brazilian policymakers to eventually lift the benchmark Selic rate back to double digits.
Since taking office in 2011, Rousseff has made lowering Brazil's historically high interest rates to single digits a top priority of her government. Eight months ago, when the Selic fell to an all-time low of 7.25 percent, it looked like her interest rate crusade was bearing fruit.
The drop in borrowing costs to what some Brazilian officials described as "developed world levels" was supposed to be a watershed moment for Latin America's largest economy, unleashing a tide of affordable credit and an unprecedented period of sustained economic growth.
Things haven't quite panned out that way. Brazil remains mired in a rut of slow growth, held back by another historical drag on the Brazilian economy - high inflation. As a result, the central bank has had to change course, raising interest rates in its last three policy meetings in a bid to bring annual inflation back to the 4.5 percent center of its target range.
Under its chief Alexandre Tombini, the central bank has increased the Selic by 125 basis points so far this year, bringing it to a 14-month high of 8.50 percent last week. It has also signaled that more hikes are imminent.
That bold action has led a small, but growing number of economists to predict that rates in Brazil could climb above 10 percent as early as next year.
"I have no doubts that Tombini will take rates to the level that he considers necessary to bring inflation expectations back to 4.5 percent," Antonio Delfim Netto, a former finance and planning minister, told Reuters in an interview on Monday, without indicating when rates might enter double digits.
"In my opinion, he will achieve his mission," added Netto, who is one of Rousseff's economic mentors.
Tombini, picked for the job by Rousseff, faces the difficult balancing act of complying with the bank's mandate to maintain price stability without hampering government efforts to jump start the economy and appease a nationwide movement against poor public services and corruption.
Some banks and consulting firms such as Santander, Citibank and Tendencias say that to curb inflation the bank will have to hike rates to over 10 percent in the next two years. The yields of interest rate futures are pricing in a rise of up to 11 percent next year.
At the start of this year most economists predicted the Selic would end 2014 at 8.25 percent. The most recent central bank poll now shows that analysts see the Selic reaching 9.50 percent by the end of next year.
Although the Selic is unlikely to climb above 20 percent like it did in 1999, it will still tower over benchmark borrowing costs in other major emerging economies like Mexico and Turkey, where rates stand at 4 percent and 4.5 percent, respectively.
Behind expectations of a higher Selic is a sell-off of Brazil's currency, the real, which has shed about 13 percent of its value in the last three months, raising the cost of imported goods like clothes, electronics and shoes.
The real has plummeted on growing worries the United States will soon start to withdraw monetary stimulus.
Less stimulus from the United States and an eventual increase in its interest rates next year will likely keep the real under heavy pressure and force authorities in Brazil to lift borrowing costs.
"You could have a heavy rate adjustment in 2015," said Marcelo Kfoury, head of the economic research department of Citi Brazil. "This very low interest rate environment will come to end... its most important effect will be on the forex front."
A slow-moving economic recovery and presidential elections in 2014 could keep policymakers from raising rates much more this and next year, Kfoury said. However, authorities will likely be forced to be more assertive in 2015 to battle inflation and currency depreciation, raising rates to 10.75 percent that year, Kfoury predicts.
GOV'T NOT HELPING
A return to double-digit interest rates would be a major political defeat for Rousseff, who has seen the once-booming Brazilian economy fall from grace despite two years of non-stop stimulus measures. She is widely expected to run for re-election next year.
Still, her government has not done much to help the central bank cap its tightening cycle.
Two years of rampant government spending have helped fuel inflation, which reached 6.70 percent in the 12-months through June - a 20-month high.
In a nod to the central bank, the Rousseff administration is putting the final details on a budget freeze of up to 15 billion reais ($6.8 billion). That may not be enough, some economists say.
"Our fiscal position is very complicated as well as the surge in (cheap) credit coming from state-owned banks," said Juan Jensen, chief economist with Tendencias Consultoria, who sees the Selic at 10 percent in 2015.
"The bank has to deliver a larger dose of monetary tightening to fight all these credit lines from public banks that usually do not respond to the Selic."
The heavy spending has raised questions about the future health of Brazil's finances, leading Standard and Poor's to warn of a possible downgrade of the country's investment rating.
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