Brazil's inflation tumbles to lowest for September since 1998

October 7, 2016 2:38 PM EDT

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By Silvio Cascione and Christian Plumb

BRASILIA/WASHINGTON (Reuters) - Brazil's inflation rate fell unexpectedly in September to its lowest for the month since 1998, paving the way for the central bank to ease cripplingly high interest rates and help pull the economy out of a harsh recession.

Consumer prices measured by the benchmark IPCA index rose 0.08 percent in September, statistics agency IBGE said on Friday. That was below all 24 market forecasts in a Reuters poll and the lowest monthly reading since July 2014.

Prices rose 8.48 percent in the 12 months through September after an increase of 8.97 percent in the previous month.

The data fueled expectations that the annual inflation rate could plunge to the official 4.5 percent target by the end of 2017 even if the central bank starts cutting interest rates at its next policy meeting on Oct. 19. Yields on interest rate futures <0#2DIJ:> dropped across the board after the data was published.

Still, central bank chief Ilan Goldfajn sought to ease any market furor by warning that the pace of disinflation continues uncertain despite the sharp drop in September.

"The evolution of prices indicates an ongoing disinflationary process, but the speed of disinflation is still uncertain," Goldfajn told investors on the sidelines of the International Monetary Fund and World Bank fall meeting in Washington.

Finance Minister Henrique Meirelles also struck a cautious tone, telling reporters in Washington that it remains to be seen if the downward trend would be long-lasting.

The lower print, though, is a sign that Brazil is slowly returning to normality after years of sharp price increases, Meirelles added.

Low inflation and rate cuts are seen as crucial to lifting Brazil's economy out of its worst recession in decades, in a boost to unpopular President Michel Temer and his ambitious agenda of budget reforms and privatizations.

Since last year, the central bank has kept its benchmark rate at 14.25 percent, its highest in a decade.

Yields on Brazil's interest rate futures indicate a 76-percent probability that the bank will cut the Selic by 25 basis points in October. The remaining 24 percent is for a 50-basis-point reduction.

The bank has insisted that any rate cuts would be conditioned to lower food prices, evidence of falling inflation and progress in Temer's fiscal agenda.

"One of the conditions that the central bank laid out to start cutting rates is becoming evident," said Newton Rosa, chief economist of SulAmerica Investimentos in Sao Paulo. "But I think the outlook for the next few months remains relatively unclear, so the bank should still be cautious and start trimming rates only by 25 basis points this time."

Goldfajn highlighted doubts about whether core inflation readings, which strips out volatile prices such as food, will also continue to drop.

The average for core inflation fell to 7.71 percent in the 12 months through September, from 8.08 percent in August. It was the first reading below 8 percent since June 2015, according to Goldman Sachs calculations.

Food prices fell 0.29 percent from August, giving back some unexpectedly sharp recent gains caused by unfavorable crop weather. Transportation costs and prices of household items also dropped in September, IBGE said.

(Writing by Silvio Cascione and Alonso Soto; Editing by Meredith Mazzilli and Chizu Nomiyama)

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