Here comes the real

March 11, 2013

Inflation is finally biting Brazilian policymakers. The real strengthened around 1.5 percent last week without triggering the usual shrill outcries from government ministers. Nor did the central bank intervene in the currency market even though the real is the best performing emerging currency this year. The bank in fact shifted towards a more hawkish policy stance during its March meeting, a move that seems to have had the blessing of the government.

Friday’s data showed the benchmark consumer price index, IPCA,   up 0.6 percent for a year-on-year inflation rate of 6.31 percent. President Dilma Rousseff, who faces elections next year, took to the airwaves soon after to reassure voters about her commitment to taming inflation, announcing a series of tax cuts. That effectively is a signal that there is now no political constraint on raising interest rates. According to the political risk consultancy, Eurasia:

If the government doesn’t enact measures during the first half of this year to anchor inflationary expectations, Rousseff would run one of two risks. She would either run the risk of inflation starting to eat into the disposable income of families in a manner that could hurt her politically, or relatedly, put the central bank in a position of having to raise interest rates more aggressively later in the year to control inflation with more negative repercussions to growth.

Accordingly swaps markets and analysts polls alike are penciling in more rate rises — the Selic rate is seen rising 75 bps by end-2013 to 8 percent. Second,  foreigners are betting on more real strength. The currency has broken 1.95 per dollar, a level that has previously triggered intervention (after spending a year hobbled in the 2.0-2.10 range) and the next level to watch for may be 1.9357, last hit in May 2009.

Bernd Berg, head of emerging currency strategy at Credit Suisse, reckons markets will keep testing the central bank’s tolerance for currency appreciation and the bank could respond with some intervention should the currency appreciate too fast. But it is not too-far fetched to expect the real to trade at 1.90 per dollar later this year, he says.

 

 

 

 

 

 

 

 

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