The Banco Central do Brasil (BCB) decided to keep the pace of monetary tightening, raising the so-called Selic rate by 50 bp to a 2-year high of 10.50%. We had expected a smaller hike of 25 bp, but highlighted the risk of a more aggressive move.
On the one hand, we argued that the rather dovish undertone of the November minutes suggested that the BCB was ready to slow down the pace of its interest rate hikes. While on the other hand, we recognised that the December surge in the IPCA inflation coupled with continued pressure on the Brazilian real could prompt the BCB to deliver another 50 bp hike. Consensus amongst economists was a 25 bp hike, while market traders were pricing in a higher chance of 50 bp than 25 bp move.
The accompanying monetary policy statement was largely unchanged, indicating that the BCB’s inflation tolerance is lower than previously thought to be. The BCB reiterated that the interest rate decision is part of an adjustment process that started in April, but added that the decision was taken “at this moment”. In our view, this suggests that the factors responsible for the decision this time might not be present at the next Copom meeting and that the BCB has not yet reached the end of its tightening cycle.
Given the magnitude of the inflation challenge – and a more devoted inflation-targeting BCB – we change our forecast for the Selic rate. Specifically, we expect the BCB to deliver another 25 bp hike in February and a final 25 bp hike in April, taking the Selic rate to 11% before going on hold.
Despite the more hawkish BCB, we maintain our bearish view on the Brazilian real (BRL). The interest rate hike of 50 bp was largely priced in by the market, and thus did not move USD/BRL. In the first part of 2014, we expect USD/BRL to weaken towards and possibly break through the 2.40 ceiling, as a deteriorating fiscal outlook increases the risk of a credit rating downgrade. However, in the very near term the BRL might strengthen towards 2.30.
It’s less about politics
Yesterday, we also stressed that the interest rate decision faced by the BCB could be tainted by politics as 2014 is an election year. Out of consideration for the already weak economic activity, the BCB might be less willing to increase interest rates further. However, an interest rate hike of 50 bp sends a strong signal that the BCB is dedicated to fighting inflation. That being said, we are not ready to call off politics in interest rate decisions altogether!
There are two things the Brazilians do not like: 1) high unemployment rates and 2) high inflation. As long as weak economic activity has not translated into rising unemployment (which is at record lows), President Dilma Rousseff should be willing to see interest rates go higher in the fight against inflation.
Nordea