By Simon Gardner

SANTIAGO (Reuters) - South American policymakers
will likely step up intervention to stem surging currency
gains, but they tread a fine line that risks fueling inflation
and could even put the brakes on a regional rate up-cycle.

Lured by higher interest rates and economic growth amid a
faltering recovery in the United States and Europe, foreign
investors are betting on the region's commodity powerhouses.
Dollar inflows are boosting currencies and hurting exporters.

Peru's central bank has aggressively intervened this year
to buy nearly $6 billion to soak up excess liquidity, while the
finance ministry said last week it would buy $500 million in
foreign exchange markets by year-end to temper its sol
currency, which is at 2-year highs.

Brazil called an auction Tuesday to buy dollars on the
spot market in a bid to boost reserves and limit currency
volatility.

The presidents of Chile and Colombia have both signaled
concern about sharp gains in their countries' currencies.

But verbal intervention will likely not be enough.

"I think the central banks will continue to intervene
heavily. The central banks that have not yet come in, will.
That means Colombia and Chile," said Flavia Cattan-Naslausky, a
strategist at RBS Securities.

"The problem with intervention is that the global
environment is still very fragile."
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Policymakers could opt to buy dollars to boost
international reserves, tax imports or offer incentives to
exporters to help counter currency appreciation.

They could also raise deposit requirements to help curb
money supply, or raise the overnight rate on interbank loans in
dollars.

Analysts say Chile is likely to delay the rate at which it
repatriates hundreds of millions of dollars to help fund
reconstruction after a massive February earthquake.

RATE UP-CYCLE TO SLOW?

Chile joined a regional rate up-cycle led by Peru and
Brazil after keeping its key rate at a record low to help the
economy recover from the quake and global crisis. But taming
currencies may slow the pace of future hikes in the region.

"By intervening in the foreign exchange market buying
dollars you throw pesos into the system (via bonds) and that
will eventually generate inflationary pressures," said Alfredo
Coutino, Latin America director at Moody's Economy.com.

"I don't see a future for a continuous (rate) heightening
cycle in Latin America," he added, saying intervention would
likely slow the pace of interest rate increases.

Chilean President Sebastian Pinera said Thursday he
would use all macroeconomic tools to keep the country's peso
competitive, but after a brief retracement, the
currency continued to surge near 7-month highs.

The same day, Colombian President Juan Manuel Santos met
with the central bank to discuss the strength of the country's
peso , which is up around 10 percent against the dollar
year-to-date.

Peru's central bank this year has sought to squeeze
speculative capital out by raising deposit requirements on
dollar loans from abroad and local bank accounts denominated in
dollars.

Despite heavy intervention, Peru's sol is up nearly 3
percent so far this year at around 2.8 per dollar, and the
market sees it appreciating by another 1.0 to 2.0 percent by
year-end.

In neighboring Chile, investors expect the central bank to
buy dollars if the peso, which has surged over 3 percent in
August alone, firms toward around 480 per dollar. The peso is
now 1.0 percent higher year-to-date.

During the 2008 commodity boom that pushed the Chilean
currency to 430 pesos per dollar, the central bank began buying
dollars on the local market to build up its reserves and the
currency weakened sharply by the year-end. It then rebounded by
more than 26 percent in 2009.

Chilean exporters are feeling the pinch, and want action.

"Producers are really affected by exchange rate variations
and intervention to ensure stability would be positive," said
Miguel Montenegro, manager of Chilean berry exporter Blue
Valley. Chile is the world's leading copper producer and is
also a major fruit, wood pulp and salmon exporter.

The Brazilian real's sharp appreciation has also hit
exporters. But traders continue to test 1.75 per dollar, even
after the government voiced support for a weaker real.

Doug Smith, head of Latin American research at Standard
Chartered in New York, expects more intervention -- whoever
wins an Oct. 3 presidential election -- via verbal warnings,
double spot auctions or reverse swaps.

However, nothing the central bank will do will come as much
of a surprise to major players in the market, says Joao
Medeiros, a partner at Pioneer Corretora, one of Brazils
biggest currency brokerages.

"The market is like a game of poker but one in which the
central bank can see everyones cards," he said. "The central
bank could do up to 10 auctions in one day if it needed to but
it won't. It has everything under control."
(Additional reporting by Samantha Pearson in Sao Paulo, Terry
Wade in Lima and Brad Haynes and Alonso Soto in Santiago;
Editing by Dan Grebler)