· Alexandre Schwartsman Antônio Gustavo Matos do Vale Eduardo Henrique de Mello Motta Loyo João Antônio Fleury Teixeira Paulo Sérgio Cavalheiro Sérgio Darcy da Silva Alves

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Date: September 14th, from 4:30PM to 7:00PM,and September 15th, from 3:55PM to 7:15PM

Place: BCB’s Headquarters meeting rooms – 8th flooron September 14th and 20th floor on September 15th –Brasília – DF

In attendance:Members of the CommitteeHenrique de Campos Meirelles – GovernorAfonso Sant’Anna BevilaquaAlexandre SchwartsmanAntônio Gustavo Matos do ValeEduardo Henrique de Mello Motta LoyoJoão Antônio Fleury TeixeiraPaulo Sérgio CavalheiroSérgio Darcy da Silva Alves

Department Heads (present on September 14th)Altamir Lopes – Economic DepartmentJosé Antônio Marciano – Department of BankingOperations and Payments SystemJosé Pedro Ramos Fachada Martins da Silva –Investor Relations GroupMarcelo Kfoury Muinhos – Research Department(also present on September 15th)Renato Jansson Rosek – International ReservesOperations DepartmentSérgio Goldenstein – Open Market OperationsDepartment

Other participants (present on September 14th)Flavio Pinheiro de Melo – Advisor to the BoardHélio José Ferreira – Executive Secretary

João Batista do Nascimento Magalhães – SpecialAdvisor to the GovernorJocimar Nastari – Press SecretaryKatherine Hennings – Advisor to the Board

The members of the Monetary Policy Committeeanalyzed the recent performance of and prospectsfor the Brazilian and international economies underthe monetary policy framework, which is designedto comply with the inflation targets established bythe government.

Recent Evolution of Inflation

1. In August, the Broad National Consumer PriceIndex (IPCA) rose by 0.69%, down from 0.91% inJuly. The IPCA fall was mainly due to the lowerimpact of tariffs that pressured the July IPCA(electricity and fixed telephone). On the other hand,bad weather conditions affected prices of fresh food.The rise in prices of sugar cane by-products alsoaffected inflation, including the indirect impact ongasoline prices (in Brazil, alcohol fuel is added togasoline). The IPCA accumulates a 5.14% change inthe first eight months of the year, and a 7.18%variation in twelve months.

2. The General Price Index (IGP-DI) rose by1.31% in August, compared to 1.14% in July, thusaccumulating a 9.53% change in the first eight monthsof the year. The acceleration of the IGP-DI in Augustwas due to higher pressures at both the wholesale andthe consumer levels. The Consumer Price Index –Brazil (IPC-Br) rose by 0.79%, while the Wholesale

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Price Index (IPA-DI) rose by 1.59%, from 0.59% and1.35%, respectively, in July. The National Index ofCivil Construction (INCC), with a 10% weight in theIGP-DI, rose by 0.81%, down from 1.12% in July. Upto August, the IPC-Br, IPA-DI and INCC accumulatechanges of 5.11%, 11.58%, and 7.79%, respectively.

3. Alcohol fuel (0.10 p.p.) and gasoline (0.07 p.p.)were the main individual contributions to the AugustIPCA inflation. Food prices rose by 0.85% (0.67% inJuly), accounting for 0.20 p.p. of the monthly IPCAchange, mainly due to the 8.1% increase in fresh foodprices. The surge in sugar cane prices led to the pricesincreases of crystal sugar (5.42%) and refined sugar(14.67%). Conversely, important products in theconsumer basket registered new price falls in August,including rice, black beans and soy oil.

4. In August, market prices increased by 0.60%(0.52% in July), accounting for 0.43 p.p. of themonthly IPCA variation, while the 0.92% increasein regulated prices was responsible for the remaining0.26 p.p. Among market prices, there werepressures coming from non-tradables, whichcontributed with 0.30 p.p. for the IPCA change,more noticeably from fresh food and maids andhousekeeping cleaners. Tradable prices contributedwith 0.12 p.p., mainly due to increases in the pricesof sugar and new and second-hand cars. Regardingregulated prices, in addition to the price increasesof gasoline and alcohol-fuel, there were residualeffects of the increases in electricity, fixedtelephone prices, and urban buses fares that hadalready pressured the IPCA in July.

5. The IPA-DI acceleration in August reflected therise of both agricultural and industrial prices. TheAgriculture-IPA increased by 0.53% (0.26% in July),due to price raises of vegetables, fruit, sugar caneand pork, while cereals and export-oriented cropscontinued to present price decreases. The industry-IPA increased by 1.98% (from 1.76% in July), mainlydue to the acceleration of prices of iron, steel and by-products, plastic materials, paper and cardboard,mechanics and electrical materials, wood and rubber.

6. Wholesale industrial prices (except fuel)accumulate a 4.97% change in the three-month periodended in August. In the same period, industrial

products (except fuel) in the IPCA register a 1.51%average increase. Therefore, there is a significantpotential of lagged impacts on consumer prices inthe next few months, due to the pass-through of thewholesale industrial inflation.

7. In August, the IPCA core inflation measured byexcluding household food items and regulated pricesregistered a 0.56% variation (0.46% in July),accumulating a 5.59% change in the year and 7.47%in twelve months. The smoothed trimmed-mean IPCAcore stood at 0.55%, the same as in July, totaling4.93% in the year and 8.01% in the last twelve months.Without the smoothing procedure for pre-selecteditems, the core recorded 0.53% (0.59% in July),4.11% in the year and 5.95% in twelve months.

8. The IPC-Br core inflation, calculated by theGetulio Vargas Foundation (FGV) under thesymmetric trimmed-mean method, stood at 0.42% inAugust (0.36% in July), accumulating 4.09% in theyear and 6.18% in the last twelve months.

9. In September, consumer-prices inflation shoulddecline, mainly due to lower pressures from regulatedprices and from fresh food prices. However,uncertainties stemming from the gap betweenwholesale and consumer industrial inflation persist.Likewise, the scenario for international oil pricesremains uncertain, constituting a potential risk todomestic inflation.

Assessment of Inflation Trends

10. The identified shocks and their impacts werereassessed according to new available information.The scenario considered in the simulations assumesthe following hypotheses:

a. The Copom’s projection for the increase of oilprices in 2004 was maintained at 9.5%, while theprojection for the increase of bottled gas prices wasreduced to 6.2% from 6.8%;

b. The projection for the readjustment of householdelectricity prices in 2004 was revised downwards to11.5% from 11.6%, while the projection for thereadjustment of fixed telephone tariffs was increasedto 13.9% from 12.8%;

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c. Regarding all regulated prices, with a total weightof 28.95% in the August IPCA, the Copom projectsan average rise of 8.5% in 2004, 0.2 p.p. higher thanprojected in the August meeting;

d. The projection for the readjustment of allregulated prices for 2005, following the model ofendogenous determination, which takes into accountseasonal components, the exchange rate, market pricesinflation and the IGP-DI change, was increased to6.9% from 6.3%;

e. The projection for the 6-month spread over theOver-Selic rate, following the specification of a VectorAutoregressive model based on the Selic and the swaprates on the eve of the Copom meeting, decreases from93 basis points in the third quarter of 2004 to 63 basispoints in the fourth quarter of 2005.

11. Regarding fiscal policy, it is assumed that theconsolidated public sector primary surplus target of4.25% of the GDP for 2004 and the following two yearswill be achieved. The related assumptions considered inthe previous Copom meeting were maintained.

12. Considering the benchmark scenario hypotheses,including the maintenance of the Over-Selic rate at16.0% p.a. and of the exchange rate close to the levelprevailing on the eve of the Copom meeting (R$2.90),the IPCA inflation was projected above the 5.5% targetfor 2004 and above the 4.5% target for 2005. Accordingto the market scenario, which takes into considerationthe consensus Over-Selic rate and the exchange rate assurveyed by the BCB’s Investor Relations Group -–Gerin on the eve of the Copom meeting, inflation isprojected above the targets for both 2004 and 2005.

Monetary Policy Decision

13. The IPCA deceleration to 0.69% in August from0.91% in July was due to lower pressures onregulated prices, while market prices rose mainlybecause of increases in fresh food prices. In 2004,market prices inflation averaged 0.60% per month(exactly the same figure registered in August). Onlyin April did this variation stay below 0.50%. Thusmarket prices inflation remained systematicallyabove the levels consistent with the inflation targetsset for this year and for 2005. Since May, the

accumulated change in 12 months of tradable, non-tradable and regulated prices in the IPCA has beenshowing an upward trend. Regarding wholesaleinflation, the IPA-DI increased to 1.59% in Augustfrom 1.35% in July. Similarly to what happened inthe past, the recent acceleration in industrialwholesale prices shall impact consumer inflationover the next few months. The intensity of this pass-through will depend on final demand conditions.

14. The IPCA cores remained relatively stable, butin high levels. In the June-August period, the coremeasured by excluding household food items andregulated prices accumulated an annualized rate of6.4%, considerably lower than the headline index(9.6%). This difference reflects the substantialcontribution of regulated prices and food to inflationin the period. Even excluding the most noticeablesources of pressure on consumer inflation in thisperiod, the 6.4% annual change signals an underlyingtrend that is not consistent with the inflation targetpath. In the year up to August, the core by exclusionis still above the headline inflation. The trimmed-meanIPCA cores also remain high, with annualized changesof 6.6% (non-smoothed) and 7.0% (smoothed) in theJune-August period, and 6.2% and 7.5%, respectively,in the accumulated of the first eight months of 2004.

15. Economic activity has continued to gathermomentum. According to the Brazilian Institute ofGeography and Statistics (IBGE), the GDP grew 4.2%in the first half of 2004 compared to the same periodof 2003, led by the manufacturing (7.3%) and trade(7.6%) sectors. Seasonally adjusted GDP grew forthree quarters in a row at annualized rates above 6%.In July, industrial production continued its upwardtrend, growing 0.5% over June (seasonally adjusted),and 1.1% in the quarterly moving average. Theindustrial production seasonally adjusted series hasbeen growing continuously since February. SinceMay, the series has been above the previous recordhigh, and, even at these high levels, presented vigorousincreases in June and July. In the three months endedin July, there was a 3.8% expansion compared to theperiod ended in April.

16. The labor market continued to respond to theactivity rebound. According to the IBGE, theunemployment rate fell in July for the third consecutive

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month, standing at 11.2%. Despite the unfavorableseasonality, unemployment rate returned to the levelsof December 2003, considerably lower than the12.8% registered in July 2003. The level ofemployment has followed an upward trend sinceJanuary, with a 0.9% growth in July, seasonallyadjusted. The level of formal employment, accordingto the Ministry of Labor and Employment, increasedby 0.8% in July, and by 4.1% in the first seven monthsof the year, with 1,236,689 jobs created in the period,compared to 598,140 and 741,977 in the same periodsof 2003 and 2002, respectively.

17. According to the monthly employment survey ofthe IBGE, the upward trend in real payroll initiated inJanuary accelerated in June and July. However, averagereal earnings grew at a slower pace, reflecting theincrease of jobs with relatively lower wages.Negotiations for wage readjustments in the first half ofthe year were very favorable to the recovery of laborincome. The Inter-union Department of Statistics andSocioeconomic Studies (Dieese) informed that 47% ofthe negotiations resulted in readjustments above theINPC inflation, while 32% had readjustments equal tothe accumulated INPC. Even with readjustments equalto past inflation, average real earnings tend to increaseif future inflation declines, comparatively to pastinflation. The current perspective is that negotiationsin the second half of this year will be highly favorableto the recovery in labor income.

18. The recovery in real earnings is an importantsource of sustainability to the expansion of theaggregate demand, and is paramount for thecontinuation of the economic rebound in a morebalanced and disseminated way. As mentioned in theMinutes of the Copom meeting in July, goods whosesales are less sensitive to credit and more sensitive toincome have been showing an accelerating growthtrend, mainly as a consequence of the recovery in thelabor market. The negative performance of the outputof semi and non-durable goods in July, with aseasonally adjusted decline of 1% in relation to June,does not seem to indicate a reversion in this trend. Inparticular, that latest result reflects a negativeperformance in the pharmaceutical products sector,which is not attributable to labor income dynamics,as opposed to the positive results of several economicactivities strongly dependent on income.

19. As the industrial production surpasses historicalhigh levels, an important concern to monetary policyis the capacity of the productive sector to accommodatethe demand expansion. According to the FGV, theindustry presented relatively low levels of idle capacityin July, and in some sectors, the installed capacityutilization was close to historical peaks. Thisinformation has been corroborated by the NationalIndustry Confederation (CNI) data, according to whichthe level of industrial capacity utilization reached 82.8%in July (seasonally adjusted), a historical record. It isimportant to notice that, as the idle capacity is reduced,there is a gradual effect over the inflation dynamics,because even when production is beyond the existinglimits, the marginal cost increases. Emergencymeasures, such as multiple shifts in production, orimports that would not be competitive in normal marketconditions, may be able to avoid shortages, but wouldnot mitigate price pressures inherent to a progressivelyhigher level of capacity utilization.

20. As the initial monetary impulse loses momentum,and the economic recovery process begins to besustained on its self-propagation mechanisms, it isnatural and sound that, at the margin, production andsales growth rates decelerate. It is even more naturaland sound that this deceleration takes place in asituation in which growth rates have been, on average,unusually high, even for initial stages of a cyclicalrecovery, and the aggregate production level hasovercome previous historical highs. Even though theindustry growth rates have declined since May, thelatest results still show a rather robust growth rate.

21. A few recent indicators have been interpretedas evidence that a more pronounced deceleration isprogressing in a spontaneous fashion, despite the factthat it is difficult to identify turning points in volatileseries, such as the ones regarding the level of economicactivity. Industrial sales fell 0.4% in July, accordingto seasonally adjusted data from CNI. The exchangerate appreciation contributed to this result, as nominalexports revenues in Brazilian Reais decreased.Packaging paper shipments fell 4.2% in August,according to data from the Corrugated PaperboardAssociation (ABPO), seasonally adjusted by the BCB.However, this decrease should be interpreted withcaution, as it follows an extraordinary increase of5.1% in the previous month. Inversely, other important

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coincident indicators still grew in August, as in thecase of vehicles and steel production. In spite of beingplausible that some spontaneous accommodation isin fact in course or on the way, there is no dataconfirming beforehand an accommodation trendintense enough to rule out any concern about apotential gap between supply and demand, as well asabout its effects over the inflation dynamics, giventhe current level of production. 22. Recent data suggests that fixed capital investmentis recovering in an encouraging way. According to thenational accounts, measured by the IBGE, the grossfixed capital formation grew 11.8% in the secondquarter of 2004, year-on-year, a better performancethan the first four quarters of each previous cyclicalrebounds in the last 10 years. Domestic absorption ofcapital goods (capital goods output plus net imports)grew 27.2% from June 2003 to July 2004, again, betterthan the 13 first months of each of the three previouscyclical rebounds. The historical series of gross fixedcapital formation shows, naturally, high degree ofcorrelation with installed capacity utilization and, withsome lags, with the sovereign risk. The performanceof these leading indicators confirms that there is roomfor expansion in fixed capital investment in the nextmonths. Although investment has been particularlypromising since the beginning of the current growthcycle, the pace of output recovery has also been moreintense than usual, which gives room to the uncertaintiesconcerning the speed at which the output gap is closing.

23. As to the external transactions, exports expandedby 34.8% in the period from January to August, inrelation to the same period of the previous year. Importsalso increased strongly (29.6%) in the same period. Thetrade balance and the current account registered surplusesof US$ 22.0 billion and of US$ 8.0 billion, respectively,in the January to August period. From January to June,the manufactured exported volume grew 25.9%.Regarding primary products, the 17.3% increase in theexported volume was accompanied by a 23.1% increasein prices. As far as imports are concerned, durable goodsvolume rose by 24.8%, while raw materials andintermediate goods increased by 21.5%, in a sharpresponse to the stronger domestic demand.

24. Recent data indicate that the growth pace of theU.S. economy has slowed down, while inflation has

remained subdued. As a consequence, a more intensehike in U.S. interest rates has become less likely. Incontrast to the tension in the second quarter of the year,international financial markets have remained calm.This favorable environment facilitated the financingof the Brazilian external needs and had positive effectsover the Brazil risk-premium and the exchange rate,which appreciated to R$/US$2.90 in the first ten daysof September, from R$/US$3.00 in August.

25. International oil prices, on the other hand, continueto be a source of concern. Even though the prices havefallen from the historical records of August, oil pricesremain high and very much sensitive to any threat to thelarger exporters supply capacity. It is important toemphasize, though, that the existing lag between domesticand international gasoline prices is being temporarilymitigated by a deviation in the international price ofgasoline from that of the crude oil. As mentioned in theAugust Copom’s Minutes, the inflationary risk associatedto oil is not only restrained to domestic gasoline prices,but also encompasses other oil intensive products.

26. Inflation expectations collected by the Gerin havedeteriorated again since the last Copom meeting. Themedian for the 2004 IPCA increased to 7.37%, from7.18% on the eve of the August meeting. As to theexpectations for the 2005 IPCA, the deterioration thathad only been affecting the mean and the standarddeviation of the distribution, finally affected the median,which increased to 5.70%, from 5.50% in August. Forthe next 12 months, the median market expectations fellto 6.19% in September, from 6.22% in August, mainlydue to the exclusion of the relatively high inflationexpectations for August/2004 and the incorporation ofa lower expected inflation rate for August/2005. Althoughthe deterioration of expectations has been triggered bythe exchange rate depreciation of the second quarter andreinforced by the concerns about oil prices, the reversionof this trend will depend not only on the recent exchangerate appreciation and an eventual more favorablescenario for oil prices but also on other developments,such as the domestic demand conditions and the inflationresults along the incoming months.

27. The Copom projections for the 2004 inflation ratehave not changed substantially since the last meeting, inboth the benchmark scenario and the market scenario.In both cases the projected inflation is above the 5.5%

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target. For 2005, the projections made in the benchmarkscenario in the previous meeting already pointed out toan inflation rate above the 4.5% target. However,projections were revised upwards due to the incorporationof greater readjustments of regulated prices for the nextyear, of 6.90%, instead of 6.3%. The market scenarioprojects inflation rates above the ones of the benchmarkscenario – thus, above the inflation target – because itassumes that there will be a slight reduction in the Over-Selic rate in 2005, and some exchange rate depreciationthroughout the projection horizon.

28. The fact that several inflation indices willovercome the 5.5% central target set by the NationalMonetary Council (CMN) for 2004 will affect, bymeans of inflationary inertia mechanisms, the inflationrate in 2005. The inertia hits both the regulated prices,due to readjustment clauses based on past inflation,and market prices, whose formation depends partiallyon future inflation expectations and partially on pastinflation. Copom’s estimates indicate that inflationaryinertia would have an impact of 0.9 p.p. over theinflation rate for 2005, in the absence of any monetaryresponse. The Copom understands that the flexibilityof the inflation-targeting regime allows for the inertianot to be fully fought in a single year, as a way topromote a smoother transition to the inflation targetsin the medium run. Similarly to the strategy that wasadopted in the past, the Committee understands thatit should fight in 2005 a third (1/3) of the referredinertia, temporarily accommodating the remaining twothirds. This decision means that the monetary policyinstruments will be calibrated in order to pursue in2005 an inflation rate of 5.1%, which corresponds tothe 4.5% central target set by the CMN, plus 0.6 p.p.related to the partial accommodation of theinflationary inertia inherited from 2004.

29. Even though the procedure employed by theCopom to estimate the inflationary inertia is very similarto the one used in the past to calculate the inertialcomponent of the adjusted inflation targets, theCommittee understands that the current circumstancesdo not recommend that adjusted target proceduresshould be entirely reproduced. In particular, the systemof adjusted targets allowed for, besides the anticipateddecision to partially accommodate the inertia inheritedfrom the previous year, new adjustments throughoutthe year by the incorporation of the primary effect of

certain shocks. The increased stability of Brazil allowsfor the monetary conduct to be guided in 2005 by apredetermined objective for inflation, restricted to thecentral target set by the CMN plus the partialaccommodation of the inflationary inertia. Theestablishment of such an objective at this moment isdue to the fact that the monetary policy has its effectsover economic activity and inflation within some lags,and therefore, requires adjustment with the dueanticipation to obtain the desired effects.

30. It is important to underline that the Copominterprets the 5.1% objective for the inflation rate in2005 as a judicious exercise of the flexibilityrepresented by the tolerance interval established bythe CMN around the central inflation target, whichremains unaltered. The fact that the monetary policywill have as an objective an inflation rate that is abovethe central target even before the beginning of theyear suggests that the new shocks that may affectthe inflation dynamics should be treatedasymmetrically. Therefore, the Copom will have tobe even less tolerant in relation to shocks that mayincrease inflation above the 5.1% objective for 2005,at the same time benefiting from eventual favorableshocks as an opportunity to bring actual inflation closeto its target path set by the CMN.

31. The Copom members agreed that, if the currentmonetary stance were maintained unchanged, thestrong economic expansion would not spontaneouslyaccommodate to a pace consistent with theconvergence of inflation to its path. The inflationprojections by the Committee confirm the increasingrisk that inflation could deviate from its targets. Inparticular, these projections already point out to aninflation rate above the 5.1% objective for 2005, underthe assumption that the Over-Selic rate is maintainedat 16% throughout the projection horizon. Theunderlying inflation trend captured by the several coremeasures is relatively steady at levels that areinconsistent with the targets. Additional risks toinflation are the deterioration of market inflationexpectations, the very indefinite outlook in the globaloil market, and the potential pressure of the increasein wholesale industrial inflation, in an environment thatfavors the re-composition of profit margins, includingthe ones stemming from wages readjustments that tendto increase average real earnings.

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32. The Copom members consensually concluded thatthe best stance was to initiate a process of moderateadjustment in the monetary policy instrument. Due tothe existing time lags between the implementation ofmonetary policy and its effects over the economy, centralbanks have necessarily to act in a preventive way,before contemporary data attests that inflation is out ofcontrol or that there are excessive demand pressures.In fact, when considering the prospective scenario forthe economy throughout a longer period, the monetarystance aims at avoiding that those risks do materialize.If current data already confirmed an inflation rate outof control or excessive demand pressures, the monetarypolicy response would have to be different from theone now considered by the Committee.

33. This moderate adjustment will aim at promotingthe convergence of inflation to the targets path, alreadyincorporating the objective of a 5.1% IPCA for 2005.By adjusting the activity recovery in the medium andlong runs with the inflation targets, the Copom willavoid more drastic measures in the future in order todisinflate the economy, with eventual significantdamages to the economic growth cycle. In this sense,the monetary adjustment main and final objective is toprovide conditions for the long run sustainable growth.

34. Another consensual agreement was the evaluationthat the adjustment should come in a gradual way,differently from the shock treatment recommended tocrisis episodes faced by Brazil in the past. Five membersof the Copom concluded that a 0.25 percentage pointincrease in the Over-Selic rate would be adequate toinitiate the adjustment process, making it as smooth aspossible, and minimizing the initial turbulence risks.The other three members voted for an increase of 0.5p.p., which, according to their evaluation, would bettersignal the magnitude of the overall adjustment requiredto bring inflation back to the targets path, and wouldbetter correspond to the optimal speed ofimplementation of this adjustment process.

35. Therefore, the Copom decided by 5 votes to 3, toincrease the Over-Selic rate target to 16.25% p.a.,without bias.

36. At the closing of the meeting, it was announcedthat the Copom would meet again on October 19, fortechnical presentations, and on the following day to

discuss the monetary policy decision, as establishedin Communiqué 11,516, of October 15, 2003.

Summary of Data Analyzedby the Copom

Economic activity

37. According to IBGE’s retail survey, in June, salesmaintained the growth trend. Compared to June 2003,real sales and nominal revenues increased by 12.8%and by 15.6%, respectively. In the first half of 2004,the expansion rates reached 9.3% and 10.0%,respectively. The regional distribution of growth wasgeneralized, encompassing all States in the country,except for Roraima. All groups encompassing theretail sector posted year-on-year growth rates in June,more noticeably in the sector of furniture and electricalappliances, which grew in a much higher pace thanthe aggregate retail group.

38. The São Paulo Trade Association (ACSP) datafor July registered a 3.1% increase in credit retailsales, while the Usecheque system consultations fell0.6%, both compared to June, s.a. In the year up toAugust, the same indicators rose by 7.6% and 1.5%,respectively.

39. The Federation of Commerce of São Paulo(Fecomercio SP) consumer sentiment survey showedthat the Consumer Confidence Index (ICC) increasedby 6.2% in September to 128.8 points (range 0 to 200).This increase was due to an 8.6% increase in futureexpectations by consumers (IEC) and an improvementof 1% in the current economic situation (ICEA).

40. Regarding fixed capital investment, the indicatorsshow deceleration in July, without characterizing,though, change in the expansion trend. The domesticabsorption of capital goods decreased by 0.5% in July,compared to June, s.a. This decrease was a result ofthe reduction of 1.1% in the domestic output and theincreases of 1% in exports and 1.1% in imports. Despitethis slight decrease, the domestic absorption of capitalgoods accumulated a 12.8% growth in the first sevenmonths of the year, compared to the same period of2003. This growth was a result of a 24.9% outputgrowth and a 7.9% increase in capital goods imports,considering the same comparison basis, which more

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than compensated the 54.5% expansion in capitalgoods exports. In July, construction inputs continuedto grow for the fifth consecutive month, posting anincrease of 1.6% compared to the previous month,s.a. In the first seven months of the year, constructioninputs grew 4.6% compared to the same period of2003. In addition to these indicators, the National Bankfor Economic and Social Development (BNDES) creditoperations increased by 43% in the period January-August 2004, compared to the same period of last year,which ratifies the investments resume. Credit toinfrastructure grew 67.8% in the same period,representing 39% of total credit outstanding. Creditoperations to industry expanded by 30.1%, while creditto the agriculture sector grew 65.7%.

41. The IBGE’s monthly industrial survey registereda 0.5% increase in industrial output in July, comparedto June (s.a.), a historical high, after five consecutivemonths of growth. Out of the 23 activities surveyed,16 registered increases in output, while out of the 4categories, 2 expanded. Intermediate goods outputincreased by 2.3%, resuming the expansion trendinterrupted last month. In the year up to July, industrialoutput increased by 7.8%, compared to the sameperiod of 2003, with output expansion in 22 out ofthe 26 activities and in all use categories, withremarkable increases of 24.9% in the capital goodsproduction and 24.5% in the durable goodsproduction. Intermediate goods output grew 6.7%,following the same trend of exports and fixed capitalinvestments. Semi and non-durable goods output grew2% in the same period, as a result of the gradualrecovery of labor income.

42. In July, the CNI recorded a 0.4% decrease in realindustrial sales and a 1.9% increase in industrialworked hours, in comparison to June, s.a. Comparedto the same month of 2003, real sales and workedhours increased by 19.5% and by 7.6%, respectively.The average level of industrial capacity utilizationreached 82.8% in July, the highest ever, with a 0.3%monthly increase (s.a.). In the first seven months ofthe year, capacity utilization expanded by 2.3%,compared to the same period of 2003.

43. In August, leading industrial indicators signal thatthe economic activity growth trend continues. Carindustry produced 198 thousand vehicles, up 3.4%

compared to July (s.a.), and 47% over August 2003. Inthe year up to August, car production increased by21.3%, while domestic sales and exports expanded by22.1% and by 17.4%, respectively, compared to the sameperiod of 2003. Steel output also grew, albeit slightly,0.3% in August, s.a. On the other hand, packaging papershipments output decreased by 4.2% in August, afterrecording a strong expansion in July (5.1%), s.a.,accumulating a 13.9% growth in the year to August.

Labor market

44. Formal employment increased by 0.8% month-on-month in July s.a., and by 5.5% compared to July2003, according to the Ministry of Labor andEmployment. In the first seven months of the year,there was a 4.1% expansion in formal employmentcompared to the same period of 2003. The dataindicate that employment has increased at a higherpace outside large urban areas.

45. The unemployment rate, measured by the IBGEin the six main metropolitan regions of the country,decreased in July for the third consecutive month, to11.2%, after peaking to 13.1% last April. Totalemployed workers increased by 0.9% in July and by2.6% in the year to July, while unemployed workersfell by 4.1% in the month. The estimated labor forcetotaled 21.5 million people, with increases of 0.3% inJuly, and 2.3% in the year, up to July.

46. Regarding the transformation industry, seasonallyadjusted data from CNI showed an expansion of 1%in employed workers and a slight decrease of 0.1% inreal payroll in July, compared to June. In the firstseven months of the year, real payroll and employedworkers increased by 7.9% and by 1.6%, respectively,compared to the same period of 2003.

47. According to data from Dieese, in the first half ofthe year, 262 wage negotiations were carried out in thecountry, which produced the best results obtained byworkers since 1996. Around 47% of the negotiationsregistered wage readjustments higher than the INPCvariation and, in 32% of the negotiations, thereadjustments were in line with the index. Moreover,there was a significant reduction in the share of wagereadjustments given in installments, which represented10% of the total in 2004, compared to 30% in 2003.

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Credit and delinquency rates

48. Non-earmarked credit operations increased by1.6% in August. Corporate credit with domesticfunding expanded by 3.2%, while corporate creditwith external funding fell by 2.9%. Individual creditoperations increased by 2.6%, accumulating 24.6%in twelve months.

49. The average interest rate on non-earmarked creditremained unchanged in August at 43.9% p.a. Thisrate was a result of the 1.1 p.p. increase of the averagerate for individuals, which totaled 63.1% p.a., despitethe fall of 0.9 p.p. in the average rate for corporate,which stood at 28.8% p.a.

50. The default rate measured by the ACSP grew to3.9% in August, after having reached 3.3% in July,the lowest level of the year. In the year to August, theaverage default rate recorded a 10.9% decreasecompared to the same period of 2003. The totalnumber of cancelled and new files increased by 10.3%and by 6.2%, respectively, in the year to August. Thenumber of returned checks, compared to the totalnumber of checks, was kept unchanged at 5.1% inJuly, also reaching the lowest level of the year.

External environment

51. Recent indicators suggest that world economicgrowth is building up in the third quarter, after somedeceleration in the previous quarter. In the U.S.,wholesale sales, civil construction expenditure andcapacity utilization grew month-on-month in July. InAugust, industrial output grew and unemploymentrate declined, while retail sales fell. In Germany,industrial output and manufacturing orders increasedin July, after decreases in the previous month. InJapan, industrial capital goods expenditure increasedin the second quarter, while in China, despite thegrowth deceleration measures, industrial output grewagain in August.

52. Regarding foreign trade, there are signs ofsignificant growth. In Japan, exports grew 14.8% inJuly, the second highest rate since 1985, and theexternal trade surplus reached US$42.7 billion in theyear up to July, compared to US$38.1 billion in thesame period of 2003. In Germany, exports also grew

in July. In August, China recorded the fourthconsecutive monthly trade surplus, 40% above the oneregistered in the same month of 2003. In the U.S., thetrade deficit reduced in July, to US$50.2 billion. Onthe other hand, in the United Kingdom, the deficit ingoods and services increased in the same month.

53. Regarding business expectations, there wasgeneralized slowdown in the main economies inAugust. However, in the U.S., expectations arefavorable, reflecting the economic momentum. Theconsumer confidence varied among the countries:there was expansion in Japan, slowdown in the U.S.and stability in the Euro Area.

54. Consumer prices indicators decreased in the maineconomies in July, alleviating the risks of inflationacceleration. In the U.S., in the Euro Area and in theUnited Kingdom, consumer price indicators declinedin July, while in China, despite the higher monthlyvariation in August, the 12-month accumulatedinflation remained unchanged at 5.3%. Wholesaleprices in the U.S. decreased in August, as aconsequence of the slowdown in the prices of oil, foodand vehicles. US core inflation, which excludeselectricity and food prices, declined 0.1%, the firstnegative value in six months. On the other hand, inChina, wholesale inflation increased in August.

55. The Bank of England kept unchanged its reporate at 4.75% p.a. In the U.S., the Federal Reservedecided to raise the target for the fed funds rate by 25b.p., to 1.5% p.a., in the August meeting.

56. In the international financial markets, thevolatility reduced and assets appreciated. Regardingthe commodity markets, there was slight retraction inthe prices of food products, and a new increase inmetal prices. Oil prices have fallen in the last weeks,but the market has remained volatile and lacking aclear trend, still representing a risk to price stabilityand to the global economic growth.

Foreign trade and balance of payments

57. The Brazilian trade balance posted a US$3.4 billionsurplus in August, while total external trade turnoveramounted to US$14.7 billion. Exports and importsincreased by 35% and by 43.9%, respectively,

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compared to August 2003 daily averages. Braziliantrade surplus reached US$1.2 billion in September, upto the second week, (7 working days), with exportsand imports growing at 30.6% and 24.6%, respectively,compared to September 2003 daily averages.

58. In August, Brazilian exports totaled US$9.1billion, registering historical records for primary,manufactured and semi-manufactured goods.Imports reached US$5.6 billion, the highest monthlyfigure in 2004, confirming the trend observed sincethe last four months of 2003. All categories of importsgrew, compared to the values of August 2003.

59. In August, the current account registered aUS$1.8 billion surplus, accumulating a US$8.0 billionsurplus in the year. In the year to August, the tradebalance and current transfers posted US$22.0 billionand US$2.2 billion surpluses, respectively, while theservices and income account posted a US$16.1 billiondeficit. Net foreign direct investment reached US$6.1billion in August, accumulating US$11.7 billion inthe year to August. At the end of August, internationalreserves stood at US$49.6 billion, while adjusted netreserves stood at US$22.6 billion (IMF concept).

Money market and open market operations

60. After the August Copom’s meeting, the domesticyield curve moved upwards for maturities up to twoyears, and moved slightly downwards for longertenures. The determinant factor underlying the yieldcurve move was the market’s interpretation of theAugust Copom’s Minutes. From August 18 toSeptember 15, the spread on the 3-month, 6-monthand 1-year rates in relation to the Over-Selic rateincreased by 0.47 p.p., by 0.28 p.p. and by 0.17 p.p.,respectively, while the 2-year and the 3-year ratesdecreased by 0.01 p.p. and by 0.17 p.p. In the sameperiod, the real interest rate measured by the ratiobetween the one-year nominal interest rate and the12-month-ahead inflation expectations increased to10.9% from 10.6%.

61. Due to the weak demand for Fx hedge, the BCBdid not carry out auctions to rollover US$1.1 billion

in securities and Fx swaps coming due on September16. As a consequence, the net redemption of Fx-linked securities and swaps in the year up toSeptember totals US$24.6 billion.

62. The National Treasury carried out one buyingand four selling auctions of LTNs, totaling a netplacement of R$9.3 billion. Four selling auctions ofLFTs were also carried out, placing R$13.2 billionmaturing in 2005, 2006 and 2007. In the same period,there were one buying auction and one selling auctionfor National Treasury Notes – Series B and C (NTN-Bs and NTN-Cs), which amounted to R$493 millionin net sales, R$155 million of which settled in currencyand the rest settled in exchange for other NationalTreasury’s securities. The expectations of increasesin the real interest caused the rise in the NTN-Ccoupons. On the August 30 auction, the rate of theNTN-C maturing in 2008 increased to 8.60% from7.75% in the previous month.

63. The BCB maintained in its open marketoperations the weekly post-fixed repo operations(2-week tenure) and the fixed repo operations (3-month tenure), as well as its daily liquiditymanagement operations (2-working-day tenure).The BCB also carried out in this period 15 fixedrate overnight repos, fourteen of which with a one-working-day tenure and one with a three-working-day tenure. The frequent overnight operations haveenabled the reduction of the gap between the Over-Selic rate and its target, from 0.13 p.p. on August18 to 0.03 p.p. on September 15. In the period afterthe August Copom’s meeting, the excess liquiditydrained from the market with operations shorterthan 30 days fell to R$31.6 billion on average, whilewith the 3-month tenure operations, it rose to R$48.8billion on average.

64. In August, the net securitized domestic publicdebt grew 0.3%. The fixed share increased to 16.7%from 15.1% in July, due to the net placement in themonth. On the other hand, the dollar-linked sharedecreased to 13.2% from 14.1%, due to the netredemption of Fx instruments and to the BrazilianReal appreciation.

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Date: October 19th, from 4:35PM to 7:15PM, andOctober 20th, from 4:00PM to 6:15PM

Place: BCB’s Headquarters meeting rooms – 8th flooron October 19th and 20th floor on October 20th –Brasília – DF

In attendance:Members of the CommitteeHenrique de Campos Meirelles – GovernorAfonso Sant’Anna BevilaquaAlexandre SchwartsmanAntônio Gustavo Matos do ValeEduardo Henrique de Mello Motta LoyoJoão Antônio Fleury TeixeiraPaulo Sérgio CavalheiroSérgio Darcy da Silva Alves

Department Heads (present on October 19th)Altamir Lopes – Economic DepartmentAndré Barbosa Coutinho Marques – InvestorRelations GroupIvan Luis Gonçalves de Oliveira Lima – OpenMarket Operations DepartmentJosé Antônio Marciano – Department of BankingOperations and Payments SystemMarcelo Kfoury Muinhos – Research Department(also present on October 20th)Renato Jansson Rosek – International ReservesOperations Department

Other participants (present on October 19th)Flavio Pinheiro de Melo – Advisor to the BoardHélio Mori – Advisor to the BoardJoão Batista do Nascimento Magalhães – SpecialAdvisor to the GovernorJocimar Nastari – Press Secretary

The members of the Monetary Policy Committeeanalyzed the recent performance of and prospectsfor the Brazilian and international economies underthe monetary policy framework, which is designedto comply with the inflation targets established bythe government.

Recent Evolution of Inflation 1. Inflation decelerated in September due mainlyto a positive behavior of fresh food prices. The lowerpressure of regulated prices also contributed to thedeceleration. Despite this favorable trend, it isimportant to stress that the inflation reduction inSeptember was in part transitory.

2. The Broad National Consumer Price Index(IPCA) rose 0.33% in September, down from 0.69%in August, accumulating increases of 5.49% in theyear and 6.71% in the last twelve months. Thedeceleration of the IPCA was due to the fall in foodprices, mainly tubercles and vegetables, as well asthe deceleration of fuel prices, particularly ofmoisturized fuel-alcohol.

3. Market prices increased 0.22% in September,compared to 0.60% in August, accounting for 0.16p.p. of the IPCA change; regulated prices increased0.59% (0.92% in August), accounting for theremaining 0.17 p.p. of the index. The readjustment of3.13% in fixed telephone tariffs was the mainindividual contributor to the IPCA in September, withan impact of 0.10 p.p. Water and sewage tariffscontributed with 0.04 p.p., following the 6.78%readjustment in the greater São Paulo that took placein August 29. Non-tradable prices inflation remainedstable in September, favored by the 4.4% averagedecrease in fresh food prices, which offset thepressures in other goods and services. Tradable priceswere up 0.40%, highlighting the increases of new andsecond-hand vehicles – reflecting, to some extent, theincrease of steel prices – as well as the prices of sugar,meat and clothing.

4. In September, the General Price Index (IGP-DI) increased 0.48%, compared to a 1.31% increasein August, totaling a 10.06% change in the first threequarters of 2004. The IGP-DI deceleration wasobserved in all its three components. The ConsumerPrice Index – Brazil (IPC-Br) increased 0.01%,after a 0.79% rise in August. The National Index

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of Civil Construction (INCC) rose 0.58%, comparedto 0.81% in August. Finally, the Wholesale PriceIndex (IPA-DI) decelerated to 0.65% from 1.59%in August, accumulating 12.31% in the first threequarters of 2004. In the last twelve months, the IGP-DI and the IPA-DI accumulated changes of 11.74%and 14.22%, respectively. 5. The reduction in wholesale inflation in Septemberencompassed both agricultural and industrial prices. Theagriculture-IPA registered a negative change of 0.64%,after a 0.53% increase in August. This result was dueto the fall in prices of vegetables, fruit, eggs, potato,wheat and rice, which prevailed over the increases inthe prices of pork, corn, coffee beans and sugar cane.The industrial IPA decreased to 1.13% from 1.98% inAugust. The most part of the industrial goods includedin the IPA decelerated, except for chemical goods, whichrose by 1.78% in September from 0.83% in August. 6. In spite of the recent deceleration, the industrialIPA (excluding fuels) accumulated a 4.8% increasein the third quarter. In the same period, the IPCAindustrial prices (excluding fuels) rose 1.3%. 7. In September, the IPCA core inflation excludinghousehold food items and regulated prices recorded0.41%, compared to 0.56% in August, thusaccumulating 7.50% in the last twelve months. Thecore under the smoothed trimmed-mean methodreached 0.56% (0.55% in August), totaling 7.69% inthe last twelve months. Without the smoothingprocedure for pre-selected items, the core decreasedto 0.38% from 0.53% in August, accumulating 5.71%in the last twelve months. 8. The IPC-Br core inflation, calculated by theFundação GetUlio Vargas (FGV) under the symmetrictrimmed-mean method, stood at 0.38% in September,compared to 0.42% in August, totaling an increase of5.87% in the last twelve months. 9. As already stressed in previous Copom Minutes,the gap between wholesale and retail industrialinflation persists, representing a potential risk overconsumer inflation, specially having in mind theseasonal demand rebound at the end of the year. Atthe same time, the increase in international oil pricesmagnifies the inflation risks.


10. The identified shocks and their impacts werereassessed according to new available information.The scenario considered in the simulations assumesthe following hypotheses:

a. For 2004, the Copom’s projection for the increaseof gasoline prices was maintained at 9.5%, while theprojection for the increase of bottled gas prices wasreduced to 4.9% from 6.2%;

b. The projection for the readjustment of householdelectricity prices was maintained at 11.5%, while theprojection for the readjustment of fixed telephonetariffs was slightly increased to 14.0% from 13.9%;

c. In regard to all regulated prices, with a totalweight of 29.0% in the September IPCA, the Copomprojects an average price increase of 8.5% in 2004,the same projection assumed in September;

d. The projection for the readjustment of all regulatedprices for 2005, following the model of endogenousdetermination, which takes into account seasonalcomponents, the exchange rate, market prices inflationand the IGP-DI change, was maintained at 6.9%;

e. The projection for the 6-month spread over theOver-Selic rate, following the specification of a VectorAutoregressive model based on the Over-Selic andthe swap rates on the eve of the Copom meeting,decreases from 81 basis points in the fourth quarterof 2004 to 59 basis points in the last quarter of 2005.

11. It is assumed that the consolidated public sectorprimary surplus target of 4.5% of the GDP for 2004and 4.25% for the following two years will beachieved. The related assumptions considered in theprevious Copom meeting were maintained.

12. Considering the benchmark scenario hypotheses,including the maintenance of the Over-Selic rate at16.25% p.a. and of the exchange rate at the levelprevailing on the eve of the Copom meeting (R$/US$2.85), the IPCA inflation rate was projected abovethe 5.5% central target for 2004 and above the 5.1%objective for 2005. Considering alternatively themarket scenario, which takes into account the

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consensus Over-Selic rate and the exchange rate assurveyed by the BCB’s Investor Relations Group –Gerin on the eve of the Copom meeting, inflation isalso projected above the central target for 2004 andabove the objective for 2005.


13. The deceleration of the IPCA to 0.33% in Septemberfrom 0.69% in August was mainly a result of the behaviorof fresh food prices, which fell 4.37% in September afterincreasing 8.14% in August. Excluding food, thedeceleration in market prices inflation in the period wouldbe significantly less intense (from 0.48% to 0.42%).Volatile prices shocks, such as those of fresh food, havean impact over the current inflation rate; however, theycause very limited effect in the future inflation trajectory.

14. Wholesale inflation also fell, favored by foodprices. However, industrial wholesale inflation remainsin a high level (1.13% in September and 15.40% in theyear). Comparing the current dynamics of industrialprices in the wholesale and in the retail segments, apotential pass-through from the wholesale to the retailprices is noticeable, causing an important source ofpressure over consumer inflation in the incomingmonths. The intensity of the pass-through will dependon price-makers future inflation expectations.

15. The IPCA core excluding household food andregulated prices and the core under the non-smoothedtrimmed mean also decelerated in September. On theother hand, the core under the smoothed trimmed mean– which aims at incorporating regulated prices to theunderlying trend of the IPCA - stood practically stable,at an annual rate close to 7%. It is important to notethat the core measures are calculated in order toeliminate part of the volatility of the headline index,but are not completely noise-free, so that marginalvariations should not be interpreted as a change inthe inflation trend. The behavior of the IPCA coresover the last few months still indicates an underlyinginflation trend incompatible with the targets path.

16. According to the Brazilian Institute of Geographyand Statistics (IBGE), industrial output grew 1.1% inAugust in seasonally adjusted terms. Such an impressivefigure was significantly higher than the market consensuson the eve of the publication of the data. Market

expectations were in fact negatively influenced by thefall in packaging paper shipments in August; this fallfollowed a sharp increase in July not fully reflected inthe industrial output performance. As mentioned in theSeptember Copom Minutes, monthly packaging papershipments are imprecise as a coincident indicator of theindustrial activity, if analyzed apart from the historicalseries. For September, the leading and coincidentindicators anticipate a slight decrease in the seasonallyadjusted monthly industrial performance. The volatilityof industrial output neither allows the interpretation of asurprisingly positive monthly figure as a definitiveevidence of acceleration in the growth trend, nor does itmean that the marginal accommodation is a clear signthat the expansion has lost momentum. In fact, Augustwas the sixth consecutive month of growth in theseasonally adjusted industrial output series. Such a longmonotonic growth had not been observed since 1994, asthe presence of some cyclical fluctuations around theunderlying trend is the most common behavior, evenduring periods of strong activity expansion.

17. The unemployment rate remained practically stablefrom July (11.2%) to August (11.4%), in a significantlower level than the one observed in August 2003(13.0%). The number of employed workers increased0.3% in August, sustaining the upward trend initiated atthe beginning of the year. According to the Ministry ofLabor and Employment, formal employment grew 0.8%in August and 4.4% in the year, which represents theaddition of 1,466,446 workers to the formal labor marketin the first 8 months of 2004. According to the Federationof Industries of the State of São Paulo (Fiesp) and to theNational Industry Confederation (CNI) surveys, realwages continued to increase. The progressive recoveryof employment and labor income will perform anincreasingly important role in the sustainability of thecurrent economic recovery process, and will alsocontribute to a more balanced expansion among theseveral economic activities.

18. The IBGE’s retail survey confirmed the expansionof personal consumption. August was the ninthconsecutive month of retail sales increase (consideringseasonally adjusted data by the BCB), despite the month’smodest performance (0.1%). Since February 2003, salesregistered only one monthly negative result (December2003), growing 9.5% in the year to August. The mostdynamic sectors at the beginning of the economic

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rebound, such as furniture and electrical appliances (up29.8% in the year), and vehicles and motorcycles (up19.2%), are still leading the retail activity. As to the superand hypermarket sales, which are less sensitive to creditconditions, growth reached 1.1% month-on-month and5.9% in the year. October data from the Federação doComércio do Estado de São Paulo (Fecomercio SP) showa significant improvement in consumer confidence, withrecord high figures for both current economic conditionsand future consumer expectations.

19. The concern expressed in past Copom Minutesabout the pace of supply growth in order to accommodatethe increasing demand without triggering inflationpressures is again emphazised. On the one hand, fixedcapital investment is encouraging, with an increase of15.7% in the domestic absorption of capital goods fromJanuary to August, over the same period of 2003. Onthe other hand, capacity utilization sustained the upwardtrend. The installed capacity utilization index measuredby the CNI grew 0.1% in August (seasonally adjusted),reaching the historical high of 83.3%.

20. The external sector has sustained its dynamism,with exports expanding 33.1% in the year toSeptember compared to the same period of 2003. Onthe same comparison basis, imports grew 29.1%,responding strongly to the rebound in domesticdemand. In the 12-month period to September, thetrade balance totaled US$32.1 billion, resulting in acurrent account surplus of US$9.8 billion(approximately 1.8% of the GDP).

21. International crude oil prices have resumed itsupward trend since the September Copom meeting.Not only did the current prices increase, but also theperspectives that prices will remain in high levels fora longer period strengthened. The risks are enhancedby the likelihood that, in face of a sustained increasein oil prices, there is a reduction in the current unusuallag in international gasoline prices. As to the domesticscenario, it is still indefinite the realignment of oil by-products prices to international prices, which increasesthe probability that such a realignment – consideringthat it can be postponed, but not avoided – couldcontaminate with greater intensity the 2005 inflationrate. Besides, a mere postponement would reduce themonetary policy effectiveness, as it expands the timehorizon in which private agents expect an imminent

inflationary shock, of uncertain magnitude, requiringhigher nominal interest rates in order to produce thesame expected real interest rate.

22. In the benchmark scenario, the Copom maintainsunchanged its projections for 2004 domestic gasolineprices; for 2005, the Copom assumes the projectionsgenerated by the endogenous determination model forregulated prices. The Committee has been carefullypondering that international oil prices face a more adverseenvironment than the current one, but still regard it as apotential risk, though increasingly higher, for thematerialization of the benchmark scenario. The Copomwill soon produce disaggregate projections for gasolineprices in 2005, as well as for the other regulated prices,when it will reassess the extent to which more adversecircumstances in the oil market should be incorporatedinto the assumptions of the benchmark scenario.

23. The international capital markets started to expressgreater concerns about the growth dynamics in the maineconomies. This uncertainty was triggered by the hikein oil prices, and resulted in greater market volatility,with immediate effects on the Brazilian foreignexchange market. The favorable scenario that enabledthe Real appreciation since last June could be harmedin the case of a larger deterioration of oil prices and itsuncertain impact over the world economy growth.

24. Since the last Copom meeting, the median ofmarket expectations for the 2004 IPCA dropped to7.16% from 7.37%. This reduction is a result of thebelow-than-expected September inflation rate, causedby the transitory factors already discussed. For 2005,on the other hand, market expectations for the IPCAincreased to 5.82% from 5.70%. The deterioration of2005 inflation expectations has not stopped yet,despite the current favorable trend of inflation, theexchange rate appreciation, the recent fall of importantcommodity prices and the signaling of a monetarytightening in the last few months.

25. Once more, the Copom emphasizes that themonetary policy adjustment is based on its owninflation scenarios, and are not conducted by inflationexpectations of private agents. However, privatesector expectations have an important impact onmonetary policy effectiveness, as they affect theexpected real interest rates corresponding to a certain

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nominal yield curve and, given demand conditions,they significantly influence price-makers decisions.Because of this relevance, inflation expectations aremonitored by the Copom and by monetary authoritiesworldwide, whichever the degree of accuracy.

26. The Copom projections for the 2004 IPCA fell,mainly due to the favorable September result. In boththe benchmark and the market scenarios, the Copomprojections for the 2004 IPCA stand above the 5.5%target established for the year, but the likelihood thatit will surpass the upper limit of the tolerance intervaldiminished. For 2005, the projections in both scenariosstand close to the values presented in the Septemberissue of the Inflation Report. In the benchmarkscenario, which assumes the maintenance of the Over-Selic rate at 16.25% p.a. and the exchange rate atR$2.85/US$ throughout the projection horizon, theReal appreciation almost counterbalanced thedeterioration in inflation expectations, maintaining theprojected IPCA above the 5.1% objective describedin the September Minutes. The projections based onthe market scenario, which incorporates the exchangerate and the Over-Selic rate expected by the marketon the eve of the Copom meeting, stand above theprojections for the benchmark scenario.

27. The Copom reiterates that it considers naturalfor the economic growth pace to spontaneously slowdown, as the initial monetary impulse loses momentumand the economy becomes to be sustained on autopropagation mechanisms linked to income increases.Although some spontaneous slowdown may be incourse, the available data do not suggest that it isintense enough to preserve the compatibility betweenthe inflation targets and the productive capacity.Despite the difficulties in measuring the installedcapacity of each industry, or, in aggregate terms, thepotential output, it is undeniable that the idle capacityhas quickly lessened in the last few months.Considering the production levels recently achieved,the monetary stance has to carefully accommodatethe marginal expansion of demand.

28. The monetary policy adjustment initiated inSeptember aims at promoting the convergence of theinflation rate to the target path, which incorporates the5.1% objective for 2005. By adjusting the output gapto the inflation target path, monetary policy will avoid

deeper damages to the growth cycle that would takeplace if more drastic measures were necessary todisinflate the economy. Preventing the inflation increaseis also essential to perverse labor income, thusmaintaining a sound and balanced recovery process.The main objective of the adjustment in monetary policyis, therefore, to ensure sustainable growth conditions.

29. As a consequence, the Copom understands thatthe current circumstances recommend the continuityof the process initiated in September, of a moderateadjustment in the Over-Selic rate. Although anincrease of 0.25 p.p. had been considered adequate tobegin this adjustment, as to smooth the inflexion ofthe monetary stance and minimize its initial turbulencerisks, the Committee evaluates that, at this moment,a 0.5 p.p. rise is more adequate with the magnitudeand the speed required to promote the convergence ofthe inflation rate to the targets path.

30. Considering the reasons stated above, the Copomdecided, unanimously, to increase the Over-Selic ratetarget to 16.75% p.a., without bias.

31. Even though the Copom assumes that the monetaryadjustment will be carried out in the magnitude and thepace originally set up, the current scenario holds twopotential new risks. First, the increase in oil prices, interms of magnitude and in terms of extent. Second, themarginal deterioration of market inflation expectationsfor 2005, even after the adjustment in the monetarystance, is an alert of its possible downward rigidity.

32. At the closing of the meeting, it was announcedthat the Copom would meet again on November 16,for technical presentations and on the following day,to discuss the monetary policy decision, as establishedin Communiqué 11,516, of October 15, 2003.


Economic activity

33. According to the IBGE’s retail survey, whichencompasses all the states of the country, retail salesincreased 0.1% month-on-month in August, seasonallyadjusted by the BCB. Fabric, clothing, shoes,furniture, electrical appliances, vehicles, motorcycles

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and parts, which had been showing expressive growthrates in the year, presented a decrease in the month,while super and hypermarkets sales remained high,considering the seasonally adjusted series.

34. Still according to the IBGE’s retail survey, theretail activity expanded 9.5% in the period January –August, compared to the same period of 2003;compared to the same month of 2003, the retailactivity expanded 7.5% in August, after fiveconsecutive monthly increases above 10%. The year-on-year growth in retail sales encompassed 26 out of27 states of the country. All activities posted year-on-year positive growth rates in August, more markedlyin the segments of furniture and electrical appliances,which grew 29.8%, well above the retail average.

35. In September, the São Paulo Trade Association(ACSP) registered a 2% decrease in the number ofconsultations of credit sales, while the Usechequesystem consultations fell 3.1%, both compared to theprevious month, seasonally adjusted. In the year toSeptember, the same indicators rose by 7.4% and by1.1%, respectively.

36. The Fecomercio SP consumer sentiment surveyindicated that the Consumer Confidence Indexincreased by 10.7% in October to 142.5 points (range0 to 200). This increase was due to an improvementof 18.1% in the current economic conditions and a7.5% increase in future consumer expectations. Thegrowth resulted in the highest consumer confidencesince the beginning of the survey, in 1994.

37. Regarding fixed capital investment, indicatorsshowed the continuity of the recovery in August.Domestic absorption of capital goods increased by 4.6%in the month, compared to the previous month, seasonallyadjusted. This increase was a result of the 2.3% rise incapital goods output and the 1.5% expansion in capitalgoods imports, as well as the decrease of 12.7% in capitalgoods exports. The domestic absorption of capital goodsaccumulated a 15.7% growth in the year to August.

38. Civil construction indicators ratify the investmentexpansion trend. Construction inputs grew 0.5% month-on-month in August, seasonally adjusted, posting thesixth consecutive month of growth, accumulating anincrease of 5.8% in the year to August.

39. The IBGE’s monthly industrial survey registereda 1.1% increase in industrial output in August,seasonally adjusted, a historical high. A sequence ofsix consecutive positive monthly results had not beenseen since 1994, after the Real Plan.

40. In the year to August, industrial output increasedby 8.8%, compared to the same period of 2003, withoutput expansion in 24 out of the 27 activities and in alluse categories. The most important growth rates in usecategories refer to the increases of 26.2% in capital goodsproduction and 26.0% in durable goods production.Intermediate goods output grew 7.3%. Semi and non-durable goods output grew 3.1% in the same period, asa result of the gradual recovery of the labor market.

41. In August, the CNI recorded a 0.1% decrease inreal industrial sales and a 0.8% increase in industrialworked hours, in comparison to July, seasonallyadjusted. Compared to the same month of 2003, realsales and worked hours increased by 20.2% and by10.7%, respectively. The average level of industrialcapacity utilization reached 83.3% in August, thehighest ever, with a 0.1% monthly increase. In the firsteight months of the year, capacity utilization expandedby 2.8%, compared to the same period of 2003.

42. Leading and coincident industrial indicators signalthat the seasonally adjusted industrial activity mayslowdown in September. Packaging paper shipmentsand steel output decreased by 3.3% and by 0.5%,accumulating in the year to September expansions of13.3% and 5.6%, respectively. The car industryproduced 203.000 vehicles, down 1.2% compared toAugust, and up 25.3% over September 2003.

Labor market

43. Formal employment increased by 0.8% month-on-month in August, seasonally adjusted, and by 6.1%compared to August 2003, according to the Ministryof Labor and Employment. In the first eight monthsof the year, there was a 4.4% expansion in formalemployment, more markedly in industry. The datahave also indicated that employment has increased ata higher pace outside large metropolitan areas.

44. The unemployment rate, measured by the IBGEin the six main metropolitan areas of the country, rose

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to 11.4% in August, from 11.2% in the previous month.The 0.3% increase in the total employment was notenough to offset the 0.5% growth of the working forcein the month. It is important to stress that the economicexpansion has its effects over the labor market by bothincreasing total employed workers and the workingforce, as people start searching for jobs as a result ofthe better economic outlook.

45. Still regarding the employment survey, average realearnings totaled R$894.81 in August, a 1.4% fallcompared to the previous month. Average real earningsgrew by 5.3% in nominal terms and fell by 0.9% inreal terms, compared to August 2003, when deflatedby the National Consumer Price Index (INPC).

46. In industry, according to seasonally adjusted datafrom CNI, employed workers and real wages increasedby 1.0% and by 1.6%, respectively, in August, comparedto July. In the first eight months of the year, real wagesand employed workers increased by 8.1% and by 2.0%,respectively, compared to the same period of 2003.


47. Non-earmarked credit operations increased by1.9% in September. Corporate credit with domesticfunding expanded by 4.1%, while corporate credit withexternal funding fell by 3.3%, as a result of the Realappreciation. Household credit operations increasedby 2.4%, accumulating 25.7% in twelve months.

48. The average interest rate on non-earmarked creditincreased by 1.2 p.p. in September, reaching 45.1%p.a. This increase was a result of the 1.6 p.p. rise inthe average corporate rate, while the average rate forindividuals remained almost stable.

49. Still regarding the non-earmarked credit, thedelinquency rate grew to 7.5% in September,compared to 7.2% from June to August. In corporateoperations, the delinquency rate remained unchangedat 3.6%, while in operations with individuals, thedelinquency rate increased by 0.5 p.p., to 13.3%.

50. The default rate measured by the ACSP grew to4.4% in September from 3.9% in August. In the yearto September, the average default rate recorded a 9.3%decrease compared to the same period of 2003. The

number of returned checks, compared to the totalnumber of checks, increased to 5.3% in Septemberfrom 5.0% in August.


51. The continuous rises in oil prices have broughtuncertainties about the sustainability of the worldeconomic growth. The price of the barrel has alreadyincreased by more than 65% this year, causing volatilityto the financial markets, specially the stock marketsworldwide. In the bonds markets, securities prices havebeen adjusting to the gradual rise in the US interestrates, benefiting emerging markets bonds. TheEmerging Market Bond Index Plus (Embi+) hasrecorded declining spreads over the American treasury,benefiting new sovereign and corporate issues. 52. Despite the continuous rises in the prices of oiland some commodities, consumer and producer priceindices have remained stable in the main economies.Considering a scenario of controlled inflation, theBank of England and the European Central Bankdecided to keep interest rates unchanged in October.In the U.S., the Federal Reserve increased the fedfunds rates by 25 b.p. in September, to 1.75% p.a.

53. In the U.S., the last indicators have reinforcedthe perception of a moderate economic growth. Thelabor market has reacted slowly. Business andconsumer expectations decreased in September. Thetrade deficit reached US$54 billion in August, andthe fiscal deficit totaled US$412.5 billion in the fiscalyear of 2004.

54. In Europe, the recovery remains slow. The lastindicators have shown deceleration in industrialgrowth in France and Germany. Low consumerconfidence, a weak recovery of employment and theoil price rises have impacted the recovery of domesticdemand. External demand also begins to shrink, afterleading the economic recovery in the area.

55. In Japan, the economy has been growingconsistently, lead by exports expansion. However, inthe last two months, industrial output and exports havedecelerated. Domestic consumption has beenmoderate, following the gradual improvement in thelabor market, but consumer confidence has recently

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deteriorated. In China, despite the restrictive economicmeasures, the outlook remains rather positive. Thetrade balance registered the fifth consecutive surplusin September, due to increasing exports.


56. In September, the Brazilian trade balance posteda US$3.2 billion surplus, accumulating US$25.1billion in the year and US$32.1 billion in 12 months.Exports and imports increased by 28.4% and by30.5%, respectively, compared to the September 2003daily averages. Total external trade reached US$14.7billion, accumulating US$115.4 billion in the year andUS$ 149 billion in twelve months. In the first 10working days of October, the Brazilian trade surplusreached US$1.7 billion, with exports and importsgrowing by 41.4% and 34.7%, respectively, comparedto October 2003 daily averages.

57. Brazilian exports totaled US$8.9 billion inSeptember. Manufactured, primary and semi-manufactured goods exports totaled US$4.8 billion,US$2.7 billion and US$1.3 billion, respectively.

58. In September, the current account registered aUS$1.7 billion surplus, accumulating a US$9.6 billionsurplus in the year. In the same period, the tradebalance posted a US$25.1 billion surplus, while theservices and income account posted a US$17.9 billiondeficit. Net foreign direct investment reached US$646million in September, accumulating US$12.4 billionin the year. The rollover rate of loans and private bondsreached 99% and 48% in the year, respectively. Atthe end of September, international reserves stood atUS$49.5 billion, while adjusted net reserves stood atUS$23 billion (IMF concept).


59. After the September Copom’s meeting, thedomestic yield curve moved upwards for maturitiesup to ten months, and downwards for longer tenures.The determinant factors underlying the downwardmove of the long-term yield curve were the reductionof the sovereign risk, the Real appreciation, theincrease of the public sector primary surplus targetand the sound external accounts. From September 15to October 20, the 1-month, 3-month and 6-month

interest rates increased by 0.35 p.p., 0.25 p.p. and0.06 p.p., respectively, while the 1-year, 2-year andthe 3-year rates decreased by 0.23 p.p., 0.39 p.p. and0.41 p.p., respectively. In the same period, the realinterest rate measured by the ratio between the one-year nominal interest rate and the 12-month-aheadinflation expectations decreased to 10.7% from 10.9%.

60. As occurred in September, the BCB did notcarry out auctions to rollover US$2.3 billion insecurities and Fx swaps maturing in October. As aconsequence, the net redemption of Fx-linkedsecurities and swaps in the year to October totalsUS$27.3 billion, including paid interests.

61. The National Treasury carried out five sellingauctions of LTNs maturing in July/2005 and January/2006, totaling a net placement of R$20.5 billion.After 6 months without carryng out NTN-Fauctions, the National Treasury resumed, in October,these auctions, maturing in January/2008, totalingR$275 million. Five selling auctions of LFTs werealso carried out, placing R$11.8 billion maturing in2005, 2006 and 2007. In the same period, there wereone buying auction and one selling auction forNational Treasury Notes – Series B and C (NTN-Bs and NTN-Cs), which amounted to R$1 billion innet terms, R$385 million of which settled in currencyand the rest settled in exchange for other NationalTreasury’s securities.

62. The BCB maintained, in its open market operations,the weekly post-fixed repo operations (tenure extendedto 4-week from 2-week) and the fixed repo operations(3-month), as well as its daily liquidity managementoperations (2-working-day tenure). The BCB also carriedout in the period 21 fixed rate overnight repos, nineteenof which with a one-day tenure. In the period, the excessliquidity drained from the market with operations shorterthan 30 days averaged R$37.8 billion, and with 3-month-tenure operations averaged R$41.5 billion.

63. In September, the net securitized domestic publicdebt grew 1.2%. The fixed share increased to 17.5%from 16.7% in September, due to the net placementin the month. On the other hand, the dollar-linked sharedecreased to 12.3% in September from 13.2% inAugust, due to the net redemption of Fx instrumentsand to the Real appreciation.

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Date: November 16th, from 4:20PM to 6:55PM,and November 17th, from 4:30PM to 8:05PM

Place: BCB’s Headquarters meeting rooms – 8th flooron November 16th and 20th floor on November 17th –Brasília – DF

In attendance:Members of the CommitteeHenrique de Campos Meirelles – GovernorAfonso Sant’Anna BevilaquaAlexandre SchwartsmanAntônio Gustavo Matos do ValeEduardo Henrique de Mello Motta LoyoJoão Antônio Fleury TeixeiraPaulo Sérgio CavalheiroRodrigo Telles da Rocha AzevedoSérgio Darcy da Silva Alves

Department Heads (present on November 16th)Altamir Lopes – Economic DepartmentDaso Maranhão Coimbra – International ReservesOperations DepartmentJosé Pedro Ramos Fachada Martins da Silva –Investor Relations GroupLuiz Fernando Maciel – Department of BankingOperations and Payments SystemMarcelo Kfoury Muinhos – Research Department(also present on November 17th)Sérgio Goldenstein – Open Market OperationsDepartment

Other participants (present on November 16th)Flavio Pinheiro de Melo – Advisor to the BoardHélio Mori – Advisor to the BoardJoão Batista do Nascimento Magalhães – SpecialAdvisor to the GovernorJocimar Nastari – Press SecretaryKatherine Hennings – Advisor to the Board

The members of the Monetary Policy Committeeanalyzed the recent performance of and prospectsfor the Brazilian and international economies underthe monetary policy framework, which is designed

to comply with the inflation targets established bythe government.

Recent Evolution of Inflation 1. Wholesale and consumer inflationaccelerated in October, but the upward move wasmitigated by the positive shock over food prices,whose effects tend to vanish in the last two monthsof the year. The disparity between the recent risesin industrial prices in the wholesale and in the retaillevel has persisted.

2. The Broad National Consumer Price Index(IPCA) rose 0.44% in October, up from 0.33% inSeptember, accumulating increases of 5.95% in theyear and 6.87% in twelve months. Fuel prices ingeneral and fuel-alcohol prices in particular werethe main contributors to the IPCA acceleration.Other regulated prices, such as air tickets and healthinsurance plans, contributed to the IPCA result.The impact of these increases was only partiallyoffset by the ongoing decline of fresh food prices.

3. The General Price Index (IGP-DI) increased0.53% in October, compared to 0.48% inSeptember, totaling a 10.65% change in the year.Among the IGP-DI components, the ConsumerPrice Index – Brazil (IPC-Br) increased 0.10%,after relative stability in September. It should behighlighted that the lesser change of the IPC-Br,compared to the IPCA, is partially justified by thegreater weight of fresh food in the former. TheNational Index of Civil Construction (INCC) rose1.19%, compared to 0.58% in September, drivenby the increase of steel product prices. Finally,the Wholesale Price Index (IPA-DI) fell to 0.61%from 0.65% in September, accumulating 13.00%in the year. In the last twelve months, the IGP-DIand the IPA-DI accumulated changes of 11.85%and 14.35%, respectively.

4. In October, market prices in the IPCAincreased 0.29% (0.22% in September),

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accounting for 0.21 p.p. of the IPCA change. Regulatedprices increased 0.80% (0.59% in September),accounting for the remaining 0.23 p.p. change of theindex, of which 0.11 p.p. were due to fuel prices. Fuel-alcohol prices increased 5.31%, while gasoline pricesrose 1.45% as a result of the 2.3% increase in refineriesprices in October and the upsurge in blended alcoholprices. Tradable goods prices increased 0.42%, withthe major pressures stemming from beef, clothing, andnew and used vehicles – reflecting, to some extent, theincrease in the prices of certain inputs, particularly steel.Non-tradable prices increased 0.13%, supported by a7.20% drop in fresh food prices.

5. The IPA-DI deceleration in October wastriggered by agriculture prices, which fell 2.73% (-0.64% in September). The prices of eggs, rice,vegetables, fruit, soy, beef, milk and corn contributedto this fall. In contrast, wholesale industrial pricesaccelerated in October, averaging 1.83% (1.13% inSeptember). Price increases were more intenseamong intermediary goods and mineral raw materials,especially iron ore, steel and by-products, fuel, plastic,plastic products, paints and lacquers.

6. Wholesale industrial prices (excluding fuel)accumulated a 5.2% rise in the quarter ending inOctober. In the same period, IPCA industrial prices(excluding fuel) registered a 1.4% increase.

7. In October, the IPCA core inflation excludinghousehold food items and regulated prices recordeda 0.55% rise (0.41% in September), accumulating7.70% in twelve months. The core under thesmoothed trimmed-mean method reached 0.60%(0.56% in September), totaling 7.51% in twelvemonths. Without the smoothing procedure for pre-selected items, the trimmed-mean core increased to0.55% from 0.38% in September, accumulating5.98% in twelve months. 8. The IPC-Br core inflation, calculated by theFundação Getulio Vargas (FGV) under the symmetrictrimmed-mean method, stood at 0.43% in October,compared to 0.38% in September, totaling 5.80% intwelve months.

9. Inflation should accelerate further in November,as a consequence of, among other factors, the second

installment of the readjustment in fixed-line telephoneservices determined by the Supreme Judicial Courtand the increases in fuel-alcohol prices and urbanbus tariffs in Belo Horizonte. The favorablecontribution of fresh food prices to inflation may besmaller in November than in October.


10. The inflation shocks and their impacts werereassessed according to new available information.The scenario considered in the simulations assumedthe following hypotheses:

a. For 2004, the Copom’s projection for the increaseof gasoline prices was maintained at 9.5%, while theprojection for the increase of bottled gas pricesremained almost unchanged, increasing to 5.0% from4.9% in the October Copom meeting;

b. The projection for the readjustment of householdelectricity prices was reduced to 10.2% from 11.5%in the October Copom meeting. The projection forthe readjustment of fixed telephone tariffs wasincreased to 14.8% from 14.0%;

c. In regard to all regulated prices, with a total weightof 29.1% in the October IPCA, the Copom projects anaverage price increase of 9.0% in 2004, up 0.5 p.p.compared to the projection in the last meeting;

d. The projection for the readjustment of allregulated prices for 2005, following the model ofendogenous determination, which takes intoaccount seasonal components, the exchange rate,market prices inflation and the IGP-DI change,was slightly increased to 7.2% from 6.9% in theprevious Copom meeting;

e. The projection for the 6-month spread over theOver-Selic rate, following the specification of aVector Autoregressive model based on the Over-Selic and the swap rates on the eve of the Copommeeting, decreases from 101 basis points in thefourth quarter of 2004 to 62 basis points in the lastquarter of 2005.

11. It is assumed that the consolidated public sectorprimary surplus target of 4.5% of the GDP for 2004

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and 4.25% for the following two years will beachieved. The related assumptions considered in theprevious Copom meeting were maintained.

12. Considering the benchmark scenario, including themaintenance of the Over-Selic rate at 16.75% p.a.and of the exchange rate at the level prevailing on theeve of the Copom meeting (R$/US$2.75), the IPCAinflation rate was projected above the 5.5% centraltarget for 2004 and above the 5.1% objective for 2005.Considering alternatively the market scenario, whichtakes into account the consensus Over-Selic rate andexchange rate as surveyed by the BCB’s InvestorRelations Group (Gerin) on the eve of the Copommeeting, inflation is also projected above the centraltarget for 2004 and above the objective for 2005.


13. Inflation measured by the IPCA accelerated to0.44% in October from 0.33% in September. Thisacceleration occurred despite the fall in food pricesfor the second consecutive month. Excluding food,market prices inflation increased to 0.54% in Octoberfrom 0.42% in September. Regulated prices werepressured by fuel prices, especially fuel-alcohol. 14. The IGP-DI accelerated slightly in October to0.53% from 0.48% in September, while the IPA-DIdecelerated, in the same period, to 0.61% from 0.65%.The acceleration of the industrial-IPA practicallyoffset the fall of the agriculture-IPA. In the year toOctober, the industrial-IPA accumulated a 17.52%change. Wholesale intermediary goods pricesincreased 2.62% in October and 23.8% in the year.The Copom will continue to monitor the potentialtransmission of wholesale inflation to consumerinflation in the coming months. The intensity of thepass-through will basically depend on future demandconditions and on the market inflation expectations. 15. According to the three methodologies used by theCopom, IPCA core inflation increased in October. Theupsurge was more significant for the core excluding foodand regulated prices and for the core under the non-smoothed trimmed mean, which had decelerated inSeptember. As stressed in the October Copom minutes,the September core results did not reflect the reversionin the underlying inflation trend but the persisting volatility

in these measures. The smoothed trimmed-mean corehas remained in the range from 0.55% to 0.60% sinceApril. Therefore, the cores have persisted in levelsincompatible with the inflation targets.

16. Industrial output, measured by the BrazilianInstitute of Geography and Statistics (IBGE), was flatin September in seasonally adjusted terms, after sixconsecutive months of growth, which had not occurredsince 1994. The September industrial results, in fact,were better than anticipated by the leading andcoincident indicators. Between January andSeptember, industrial output grew 9.0% compared tothe same period of 2003.

17. Leading and coincident indicators anticipate adecrease in industrial output in October (seasonallyadjusted). However, this specific outcome does notindicate that industrial output is reverting the growthtrend, as isolated positive performances do notindisputably indicate acceleration in the growthrhythm. After the uninterrupted growth from Marchto August, some accommodation is expected becauseindustrial activity is volatile, with short-termoscillations around the growth trend. Methods aimedat diminishing this volatility, such as the three-monthmoving average of the seasonally adjusted series, showa continuous output expansion since February,although at lower positive rates in recent months. 18. In addition to converging to a more moderategrowth pace, growth dynamics have continued todisseminate. In the recent past, the relative importanceof the industries more sensitive to income has increased,disregard of the activities more sensitive to credit, whichleaded the initial stages of the recovery process. 19. The activity rebound in the last five quarters hascontinued to positively affect the labor market.According to IBGE data, the unemployment ratedecreased to 10.9% in September from 11.4% inAugust, sustaining the downward trend initiated inApril. From January to September, urban employmentand real wages increased 3.0% and 1.8%, respectively.Formal employment measured by the Ministry of Laborand Employment increased 0.5% in September and4.6% in the year, representing the creation of 1,666,188jobs. Industry was responsible for the highest share ofjob creation, with net hirings expanding more than 100%

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in comparison to last year. Data from the NationalIndustry Confederation (CNI) confirm this trend,indicating a continuous growth of industrial employmentsince December. The CNI also showed that real wagesin manufacturing continued to grow in September,sustaining the trend initiated in March 2003.

20. The IBGE’s retail survey showed stable sales inSeptember (data seasonally adjusted by the BCB). Inthe year to September, sales and nominal revenuesincreased 9.32% and 12.06%, respectively. Furnitureand electrical appliances, and vehicles andmotorcycles continued to lead the retail expansion,supported by credit conditions. However, similarlyto what has happened to industry, less credit-sensitivesegments, such as clothing, and super andhypermarkets, have gained momentum. Consumerconfidence measured by the Federação do Comérciodo Estado de São Paulo (Fecomercio SP) continuedto improve in November, a trend initiated in August.

21. Considering the activity expansion since the secondhalf of 2003, a critical concern of the Copom is theperformance of aggregate supply. Capacity utilizationmeasured by the FGV grew to 86.3% in October,compared to 84.5% in July, reaching a historical highsince the beginning of the quarterly survey in 1990.Construction material posted the fastest increase,reaching 85.8% from 80.5% in July. Final consumergoods and intermediate goods, which had already beenat high capacity levels, experienced additional increases,while capital goods slightly decreased. Among industrialsectors, mechanics, electrical and communicationsmaterials and food products not only increased capacityutilization levels throughout the year, but also reachedhistorical highs. In contrast, CNI monthly data indicateda slight decrease in capacity utilization in September, inseasonally adjusted terms, after having peaked in August.

22. The domestic absorption of capital goodsdecreased 0.6% in September, driven by the 2.5% dropin the domestic production of capital goods (seasonallyadjusted data). This result does not indicate a limit orreversion in the fixed capital investment recovery trend,since the monthly series is highly volatile - in August,for example, a 2.0% expansion was registered. In theyear, the absorption of capital goods grew 16.2%,mainly led by the 25.7% expansion in the domesticproduction of capital goods. As stressed in past Copom

minutes, fixed capital investment is highly correlatedwith capacity utilization and, notwithstanding the longerlag, with the sovereign risk. The recent trend of theseleading indicators suggests that there is room for fixedcapital investment to expand in the coming months,beyond the expansion already registered in the nationalaccounts up to the second quarter of 2004.

23. Exports have continued to expand vigorously,accumulating a 31.1% rise in the year to October.Manufactured products, which represent about 56%of total exports, expanded by 23.8% in volume termsin the year to September, compared to the same periodof 2003. Imports increased by 27.3% in the year toOctober, fuelled by the recovery in domestic demand.Raw materials and durable consumer goods led theimports expansion, growing by 22.9% and 24.6%,respectively. In the twelve-month period to October,the trade surplus totaled US$32.6 billion, resultingin a current account surplus of US$10.8 billion(approximately 1.95% of the GDP).

24. The international scenario has settled down sincethe last Copom meeting, mainly reflecting subduedoil prices, which contributed to the reduction in theBrazilian country risk and to the BRL appreciationagainst the dollar. However, the sustainability of thisbenign scenario will depend on new data regardingthe performance of the OECD economies, especiallythe US, and the evolution of international crude oilprices. International capital markets expect theFederal Reserve to continue the gradual tightening,although recent activity and inflation data areinconclusive about the current economic trend and,as a consequence, the future monetary stance.

25. After historical records in October, crude oilprices have fallen. However, the spot and futures oilprices persist at higher levels than, for instance, thoseprevailing on the eve of the September Copommeeting. Expectations about oil prices, currentlycentered on the magnitude and continuity of the recentdecrease in prices, remain uncertain. Nevertheless,this trend validates the Copom forecasting scenario,where high oil prices were treated more as a latentrisk and not as a baseline hypothesis.

26. The Copom projection of a 9.5% readjustmentof gasoline prices in 2004 did not change, despite the

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recent increase in fuel-alcohol prices. For 2005, theCommittee has continued to work with aggregateprojections for regulated prices, generated by anendogenous determination model. A preliminarydisaggregate analysis confirms, in general terms, themodel’s aggregate projection, assuming domesticgasoline prices maintain their historical correlationwith international oil prices.

27. The median of IPCA expectations for 2004slightly increased to 7.19%, from 7.16% on the eveof the October Copom meeting. Despite the BRLappreciation, the recent fall of important commoditiesprices and the monetary tightening, 2005 inflationexpectations continued to deteriorate, standing at5.90%, up from 5.81% in October.

28. The Copom inflation projections for 2004 wereunaltered, but the risk that the IPCA surpasses the8% upper limit of the tolerance interval hasdiminished. For 2005, the inflation projections in boththe benchmark and the market scenarios havedecreased, compared to the October’s estimates. Inthe benchmark scenario, which assumes unchangedOver-Selic and exchange rates at 16.75% p.a. and atR$/US$2,80, respectively, the BRL appreciation andthe upward move in the yield curve more thancounterbalance the worsening of inflation expectationsand the projected increase in regulated prices.Nevertheless, the estimated IPCA remains above the5.1% inflation objective. The projections based onthe market scenario, which incorporate the consensusOver-Selic and exchange rates on the eve of theCopom meeting, stand above the projections on thebenchmark scenario, due to the expected depreciationof the exchange rate throughout the projection horizon.

29. Since the October Copom meeting, the decline ininternational oil prices, the BRL appreciation andevidence of activity deceleration have materialized. Thesefactors have not yet been able to substantially alter thefuture inflation prospects, despite the recent change inthe monetary stance. For this reason, the Copom decidedto maintain the rise of the Over-Selic rate, as to ensurethe convergence of the inflation rate to the targets path.

30. This adjustment in the Over-Selic rate willprevent more drastic adjustments in the future, in orderto disinflate the economy, which could seriously

damage the growth cycle. Furthermore, thesustainability of the economic rebound initiated in2003 depends on the convergence of inflation to thetarget path, supporting the components of domesticdemand more dependent on labor income. In otherwords, the monetary policy adjustment process aimsat reducing output volatility and at providing long-term sustainability to economic growth.

31. Considering the reasons stated above, the Copomunanimously decided to increase the Over-Selic ratetarget to 17.25%, with no bias.

32. As mentioned in the October Copom Minutes, theCommittee emphasizes that the maintenance of themonetary adjustment in the magnitude and in the paceinitially designed, requires that the risk factors do notexacerbate. Among other aspects, it is important forthe recent scenario of international oil prices not todeteriorate and for the rigidity of inflation expectationsto reverse. If the Copom assesses an enhanced risk ofinflation deviating from the target path, it will beprepared to alter the pace and the magnitude of themonetary adjustment process initiated in September.

33. At the closing of the meeting, it was announcedthat the Copom would meet again on December 14,for technical presentations, and on the following dayto discuss the monetary policy decision, as establishedin Communiqué 11,516, of October 15, 2003.


Economic activity

34. According to the IBGE’s retail survey, whichencompasses all the states of the country, sales werestable in September in seasonally adjusted terms.

35. Retail sales expanded 9.3% in the year toSeptember, compared to the same period of 2003.Against September 2003, sales grew 8.9%,encompassing 25 out of the 27 states of the country.

36. The São Paulo Trade Association (ACSP)registered a 1.1% fall in credit retail sales in October,while the Usecheque system consultations increased3.9%, compared to the previous month. In the year

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to October, the same indicators rose by 6.5% and1.0%, respectively.

37. The Fecomercio-SP consumer sentiment surveyshowed that the Consumer Confidence Index (ICC)increased by 2.2% in November to 145.6 points (range0 to 200). This increase was due to a 3% increase infuture expectations by consumers (IEC) and animprovement of 0.4% in the current economicsituation (ICEA).

38. Regarding fixed capital investment, the domesticabsorption of capital goods decreased by 0.6% inSeptember, compared to August, consideringseasonally adjusted data. This decrease was a resultof the 2.5% reduction in domestic output and theincreases of 2.1% in exports and of 4.3% in importsof capital goods. Despite the increase of 47.7% in theexports of capital goods, the domestic absorption ofcapital goods grew 16.2% in the year to September,due to the 25.7% rise in domestic production and tothe 11.6% increase in imports.

39. Construction indicators were stable in September,after six consecutive months of expansion. Theproduction of inputs for construction fell 0.3% month-on-month, but grew 6.3% in the year to September.

40. Industrial output, measured by the IBGE, remainedstable in September, in seasonally adjusted terms, aftergrowing from March to August. In the third quarter,industrial output grew 2.6% (quarter-on-quarter), and10.5% compared to the same quarter of 2003.

41. According to the IBGE’s industrial survey,production expanded in 12 industrial activities inSeptember and contracted in another 11 activities.Among the use categories, semi and non-durablegoods led the performance of industry.

42. In the year to September, industrial output grew9.0%, when compared to the same period of 2003.Output expanded in all use categories and in all the 27industrial activities surveyed, except the pharmaceuticalindustry. Capital goods and intermediary goods outputgrew 25.7% and 7.4%, respectively, favored by theincrease in exports and in fixed capital investment. Theproduction of durable goods increased 25% and of semiand non-durable goods grew 3.9% in the same period,

reflecting the gradual recovery of the components ofdomestic demand dependent on labor income.

43. In September, the CNI recorded a 2% decline inreal industrial sales and a 0.1% decline in industrialworked hours, compared to August, consideringseasonally adjusted data. Compared to the same monthof 2003, real sales and worked hours increased by15.6% and by 7.3%, respectively. The average levelof industrial capacity utilization reached 82.9% inSeptember, with a 0.4 p.p. decrease in relation toAugust. In the first three quarters of the year, capacityutilization expanded by 3% compared to 2003.

44. Leading indicators (packaging paper shipments,steel output, tolls in highways and cars production)suggest a reduction in industrial output in October.Despite the October negative performance, thoseleading indicators have grown notably in the year,reaching record highs.

Labor market

45. Formal employment increased by 0.5% month-on-month in September, seasonally adjusted, and by6.2% compared to September 2003, according to theMinistry of Labor and Employment. In the first threequarters of the year, there was a 4.6% expansion informal employment, with the creation of 1,666,188jobs. Job creation was led by manufacturing, followedby construction and services. Data have also continuedto indicate that employment has increased at a higherpace outside large metropolitan areas.

46. The unemployment rate, measured by the IBGEin the six main metropolitan areas of the country, fellto 10.9% in September, down from 11.4% in theprevious month. The fall in the unemployment ratereflected the effects of the activity rebound on thelabor market. The number of employed workersincreased by 1% in September, above the 0.5%increase of the working force.

47. Average real earnings totaled R$910.10 inSeptember, a 1.9% increase compared to the previousmonth. Average earnings grew by 9.1% and by 3.2%in nominal and real terms, respectively, compared toSeptember 2003, when deflated by the NationalConsumer Price Index (INPC).

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48. In September, employed workers and real wagesin industry increased by 0.8% and by 0.9%, respectively,month-on-month, according to seasonally adjusted datafrom CNI. In the first nine months of the year, employedworkers and real wages increased by 2.4% and by 8.5%,respectively, compared to the same period of 2003.


49. Non-earmarked credit operations increased by 2%in October. Corporate credit with domestic fundingexpanded by 3.4%. In twelve months, this segment grewby 27.4%, driven by more intense economic activity.Corporate credit with external funding fell by 0.5% inOctober, as a result of the BRL appreciation and of theamortization of debts. However, these operations grewby 10.4% in the year to October. Credit operationswith individuals increased 1.9% in October and 25.8%in the last twelve months as a result of the higher volumeof personal credit operations.

50. The average interest rate on non-earmarked creditincreased by 0.5 p.p. in October, reaching 45.6% p.a.This increase was a result of the 0.7 p.p. rise in theaverage corporate rate, which stood at 31.1% p.a.The average rate for individuals remained stable inthe period at 63.2% p.a.

51. The default rate measured by the ACSP fell to4.1% in October from 4.4% in September. In the yearto October, the average default rate recorded a 10.6%decline when compared to the same period of 2003.


52. The price of oil reached an historic high onOctober 22, when the WTI and the Brent stood atUS$56.17 and US$51.92, respectively. Since then,oil prices have declined, posing fewer risks to globaleconomic growth. The stock exchanges reactedfavorably to the fall in oil prices.

53. The US current account deficit has continued toinfluence the dollar depreciation, and the US$/Euroexchange rate reached a new historic high above 1.30.The dollar depreciation has been mainly absorbed bythe euro, since Asian central banks continued tointervene in the exchange market, aiming atmaintaining the competitiveness of their currencies.

54. In mid-June, the volatility of the 2- and 10-yeartreasuries diminished, as it became more clear theFederal Reserve strategy of gradual tightening. Sincethen, Treasury yields have been driven by new economicindicators and geopolitical developments in Iraq. Thepurchase of U.S. securities by Asian central banks hashelped to smooth the movements in the yield curve.

55. The third quarter GDP data confirmed the U.S.economic expansion. In Japan, GDP growthdecelerated to 0.3% in the last quarter, with thedeflation risk still evident in the GDP deflator. In theEuro-area, growth decelerated to 1.2% in annualizedterms in the third quarter.

56. The Federal Reserve increased the Fed funds targetto 2% in the November FOMC meeting, confirmingthe strategy of moderate adjustments. The producerprice index recorded a 4.4% annual rise in October,pressured by oil prices. However, core inflation stoodbelow 2%. In the Euro-area and in the UK, short-terminterest rates stood at 2% and 4.75%, respectively.


57. In October, for the sixth consecutive month, theBrazilian trade balance posted a US$3 billion surplus,accumulating US$28.1 billion in the year and US$32.6billion in twelve months. Exports and imports increasedby 34.4% and by 33.4%, respectively, compared tothe October 2003 daily averages. Total external tradereached US$14.7 billion in October, accumulatingUS$130.1 billion in the year to October and US$151.1billion in twelve months. In the first two weeks ofNovember (nine working days), the trade surplusreached US$1.2 billion, with exports and importsgrowing by 41.0% and 33.7%, respectively, comparedto November 2003 daily averages.

58. Brazilian exports totaled US$8.8 billion inOctober. Manufactured, primary and semi-manufactured goods exports totaled US$5.3 billion,US$2.3 billion and US$1.1 billion, respectively.Besides the increase in volumes, important exportproducts, such as steel products, oil, gasoline, pork,coffee, sugar, cotton and tobacco have registeredprice increases. Imports reached the highest levelin the year, totaling US$5.8 billion in the month, withincreases in all categories.

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59. At the end of October, international reservesstood at US$49.4 billion, while adjusted net reservesstood at US$22.2 billion (IMF concept).


60. After the October Copom meeting, futuresinterest rates for maturities up to one year increased,while rates for longer maturities decreased. The longerend of the yield curve was influenced by the fall of oilprices, the decline in country risk, the BRLappreciation, operations in the derivatives market andexpectations that monetary policy will enable aquicker convergence of the inflation rate to the targetpath. Between October 20 and November 17, the 1-month, 6-month and 1-year interest rates increasedby 0.71 p.p., 0.49 p.p. and 0.20 p.p., respectively,while the 2-year and the 3-year rates decreased by0.12 p.p. and 0.26 p.p. In the same period, the realinterest rate measured by the ratio between the one-year nominal interest rate and the 12-month-aheadinflation expectations reached 10.8%.

61. Due to the low demand for FX hedge, the BCB didnot carry out auctions to rollover US$656 million in Fx-linked securities and swaps maturing on November 10,similarly to what occurred in the two previous months.As a consequence, the net redemption of Fx-linkedsecurities and swaps in the year to November totalsUS$28.2 billion, including paid interest.

62. Between the October and November Copommeetings, the National Treasury carried out four sellingauctions and two buying auctions of LTNs, totaling a

net placement of R$9.7 billion. Still regarding LTNs,the National Treasury substituted the maturities ofOctober 2005 and July 2006 for July 2005 and January2006. The National Treasury also carried out two NTN-Fs auctions maturing in January 2008, totaling R$169million, and six LFTs auctions maturing in 2005, 2006and 2007. The net sales of LFTs totaled R$9.8 billion.In the same period, there was buying auction and oneselling auction for NTN-Bs and NTN-Cs, whichamounted to R$363 million in net terms.

63. In its open market operations, the BCB carriedout a new operation two times, aimed at reducing theliquidity at the beginning of 2005. This operationconsisted in a selling auction of LTNs maturing inApril 2005 linked to a buying auction of LTNsmaturing in January 2005. The operation totaledR$4.0 billion. In addition, the BCB maintained theweekly post-fixed repo operations (4-week tenure) andthe fixed repo operations (3-month), as well as itsdaily liquidity management operations (two-working-day tenure). The BCB also carried out 17 repos inthe period, fifteen of which were overnightborrowings, one with a two-working-day tenure andanother with an overnight lending. In the period, theexcess liquidity drained from the market withoperations shorter than 30 days averaged R$30.1billion, and with 3-month-tenure operations averagedR$41.5 billion.

64. In October, the net securitized domestic publicdebt grew 0.7%. Due to the net redemption of Fxinstruments, the dollar-linked share decreased to11.2% in October from 12.3% in September.

Documents

· Alexandre Schwartsman Antônio Gustavo Matos do Vale Eduardo Henrique de Mello Motta Loyo João Antônio Fleury Teixeira Paulo Sérgio Cavalheiro Sérgio Darcy da Silva Alves