By Win Thin
Brazil central bank hiked rates 50 bp late yesterday to 11.25%, as expected, though some chatter was heard about a possible 75 bp move. It said the move was the beginning of an adjustment process that along with “macro prudential” measures (what it called reserve requirements when it hiked them back in December) would move inflation back to the 4.5% target. What they are implicitly saying is that they do not want to put the entire burden of adjustment on higher policy rates, but will instead use reserve requirements and other administrative measures to help limit credit expansion and price pressures. The fact that policy-makers have also introduced more measures to help limit BRL strength in recent weeks tells us that concern remains very high regarding the exchange rate. As we’ve written before, Brazil (and others in EM) is trying to target too many things. The central bank simply cannot adequately target both inflation and the exchange rate with its monetary policy.
We are very bullish on the Brazilian economy and believe that aggressive SELIC hikes will be necessary. Latest central bank survey shows the market is looking for only another 100 bp of tightening by year-end, which we do not think will be enough to cool the economy even with other measures that are likely to be rolled out. We think it likely that it front-loads its hikes with 50 bp at each of the next meetings – March 1/2, April 19/20, and June 7/8. After that, there are four more meetings in H2 and what happens next will really depend on how the economy and BRL is performing then. Fiscal policy remains expansive, and while we hope that this will be pared back now that the elections are over, November budget data remained worrisome as recent improvements have been due largely to the Petrobras share offering. Add in all the infrastructure spending that is on tap for the World Cup and the Olympics, and one gets the picture that the monetary/fiscal policy imbalance is likely to continue.
For now, USD/BRL is in a narrow trading range of 1.65-1.70 that has for the most part held since mid-December. Any moves below 1.65 will surely be met by more capital controls and measures, while investors seem keen to buy BRL on any moves toward 1.70. And as we’ve pointed out before, investors will be very happy to pick up the high (and rising) interest rates along with a stable exchange rate. Despite all the measures taken to weaken the real, it is down only 0.6% YTD vs. the dollar.