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Diverging Inflation Paths In Brazil And Mexico

By Win Thin

We are seeing divergent inflation paths in Brazil and Mexico, and today’s mid-April data underscored this point.

Mid-April IPCA inflation rose 0.77% m/m and 6.44% y/y. This is the highest y/y rate since mid-July 2005, when the policy rate was at its high of 19.75% for that cycle. We expect 50 bp of tightening when COPOM announces later tonight, and also believe further hikes are likely at the June 7/8 meeting. According to the last survey by the central bank, inflation expectations continue to creep higher, now at 6.29% for end-2011 vs. 6.26% last week and also close to the 6.5% ceiling. Strangely, market is looking for end-2011 SELIC rate of 12.25%, which is where we’ll be if COPOM delivers a 50 bp hike today. We think there is further upside potential for rates. USD/BRL continues to feel heavy, and the return of risk appetite saw the pair trade to a new cycle low of 1.5607 today. As we wrote yesterday, “We maintain our view that USD/BRL will continue to move from range to range, trading de facto more as a crawling peg than a free floating currency. The current range is still to be determined, but we suspect that the lower bound for USD/BRL lies around 1.55 and that policymakers will defend that level for the time being. But it could very well be USD/BRL 1.50.”

Meanwhile, Mexico reported inflation of 3.2% y/y in mid-April, 3.21%, up from the 3% y/y rate posted in mid-March but still well within the central bank’s 2-4% target range. We may have seen the trough already for inflation, but the upward creep is likely to be slow. Core rose 3.2% y/y vs. 3.1% y/y in mid-March. The central bank meets May 27, and no one is expecting a move then. Indeed, it’s clear from recent dovish comments by Governor Carstens that he is not very concerned about price pressures. Surveys show analysts do not expect any move by Banco de Mexico until Q1 12, and for the most part this has not budged in recent months. Even if no hike is seen until 2012, MXN still enjoys a nice yield advantage at 4.5%, second highest (tied with Chile) in the region behind Brazil. Note that policy rate pre-Lehman high was 8.25% for that cycle. What’s more important, we continue to believe Mexico policy-makers are not concerned about peso strength as much as others in EM and so we see low risk of intervention or capital controls for MXN until we get closer to 11.0-11.5. Note that COP, MXN, and BRL are top Latin American currencies YTD and are also in the top ten for all of EM YTD.

Brazil Interest Rates and Inflation

Mexico Interest Rates and Inflation

Source: Bloomberg

Win Thin

About 

Win Thin is the Head of Emerging Markets Currency Strategy at Brown Brothers Harriman. He has a broad international background with a special interest in developing markets. Win received his Ph.D. in economics from Columbia University in 1995, specializing in international and development Economics. He received an MA from Georgetown University in 1985 and a B.A. from Brandeis University 1983.