Brazil Rate Hike Chatter Picks Up

by Win Thin

Chatter about possible Brazil rate hike today is picking up after November IPCA inflation rose 0.83% m/m and 5.63% y/y. The y/y rate is the highest since February 2009, when the SELIC policy rate was 12.75%. While there is a risk of a surprise move today, we think it more likely that the tightening cycle starts next month, when incoming central bank chief Tombini will likely hike the SELIC policy rate 50 bp at his first meeting January 18/19. The central bank hiked reserve requirements this month, which we think delays the SELIC hike until next month. Weekly central bank survey shows market is still looking for an end-2011 policy rate of 12.25%, up from 12.0% in November and 11.75% in October. However, we continue to think that the rate could go as high as 12.75% next year from 10.75% currently.
A potentially positive development for Brazil was a report that there may be a plan to cut lending by development bank BNDES. Excessive quasi-fiscal easing by BNDES is unwarranted, in our view, but has continued to lend aggressively at low interest rates even as the central bank tightened in 2010. BNDES’ long-term TJLP lending rate has been stuck at 6% since July 2009 despite 200 bp of hikes in the benchmark SELIC rate this year. Any move to pare BNDES lending back would be good in terms of policy balance, as some of the burden of adjustment would be taken off of monetary policy. Fiscal policy remains one of Brazil’s weak spots, and it will be very important for Rousseff to set the tone for tighter policy in her first months in power. For instance, we hope that the primary surplus be brought back up to 4% of GDP from recent levels near 2% (ex-Petrobras share sales).

Despite generalized softness in EM today, USD/BRL is holding up well and remains below the bottom of its recent 1.70-1.75 range for a third straight day. We are impressed by BRL resilience, and some in the market are speculating that the heightened need for monetary tightening may lead Brazil policy-makers to accept more currency strength as a way of taming price pressures. That is possible, but we need to see how they react during this current move below 1.70 and whether other FX measures will be rolled out on any significant break towards 1.65. Policy-makers in Brazil have so far remained quiet during this week’s BRL gains, and may be waiting to see how the euro zone crisis plays out. Further intensification of the crisis would very likely drag USD/BRL back above 1.70 and toward 1.75.