Brazil Inflation Report Signals Rate Hike In January
by Win Thin
Brazil central bank’s quarterly inflation report was quite hawkish, and caught the market off-guard after the decidedly more dovish minutes from the December 7/8 COPOM meeting were reported last week. In those minutes, the central bank put a lot of weight on its decision to hike reserve requirements December 3, calling it a “fast and powerful” tool to contain domestic demand pressures. Some took this as a dovish slant with regards to less need for SELIC rate hikes, but we disagreed then. Now, the bank wrote of the need to hike rates “in the short term.” We think this cements a 50 bp hike at Tombini’s first meeting January 18/19. We remain very bullish on the Brazilian economy and believe that COPOM must continue to tighten policy over the course of 2011. Brazil price pressures are largely demand driven, in our view, and with the economy continuing to growth above trend (thought to be around 4.0-4.5%), we see fairly aggressive tightening ahead.
We do acknowledge that economic data has been on the soft side recently, but with fiscal policy still expansionary and much spending in the pipeline due to the 2014 World Cup and the 2016 Olympics, we think momentum will remain strong in the economy. We continue to look for further IOF hikes if the tightening cycle leads to further BRL gains. Despite the recent EM correction, BRL is holding up well and remains smack in the middle of the 1.65-1.75 range seen in Q4. We have been impressed by BRL resilience in general, and foreign investors are likely satisfied with basic BRL stability when collecting interest payments. Further intensification of the euro zone crisis would very likely drag USD/BRL back toward 1.75, where buyers have generally emerged and prevented trading above that level since September 1. But for now, markets appear to be quite comfortable with the overall Brazil outlook.