BRL: Public finances and politics to limited the upside – Nordea Markets

According to Morten Lund, Research Analyst at Nordea Markets, the recent depreciation of the Brazialian Real spurred anticipation among some market participants that the Brazil Central Bank will hike interest rates. They see public finances and politics as another factors that will limit BRL upside.

Key Quotes:

“During the truckers’ strike USD/BRL traded at 3.90, which were levels not seen since the recession in 2015 and early 2016, before the BCB stepped in and offered FX in extraordinary FX swap auctions. The BCB interventions have stopped the BRL from bleeding somewhat although USD/BRL after yesterday’s spill-over effects from the plummeting ARS still trades at relatively weak levels – levels, which have spurred some anticipation among investors that the BCB might choose to also hike interest rates in the coming months.”

“We expect more FX swap auctions and verbal interventions from both the central bank and finance minister Eduardo Guardia will be used as was also the case on the back of fear of rising contagion risk from Argentina. Should the situation escalate, we would also expect the BCB to use direct FX spot sales and increase credit lines, leaving an emergency hike a measure of last resource. We believe that a potential emergency hike will not come into play before USD/BRL would reach levels around 4.05-4.15.”  

“We do not expect the BCB to hike this year due to the current inflation development. Thus, the BCB has never hiked with an inflation gap in negative territory and while we acknowledge that the degree of FX pass-through to inflation is relatively high, we do not expect it to be enough to justify a rate hike in 2018 as earlier negative inflation gaps similar to the current have never been followed by a rate hike in the following 12 months.”

“The recent truckers’ strike and turmoil in the financial markets combined with falling confidence indicators and political uncertainty all points towards lower economic activity and lower growth rates than expected. Hence, accommodative monetary policy is still needed to underpin investment and credit growth.”

“Our view is at least more dovish than consensus as we do not expect the BCB to begin its rate hiking cycle before 2019 with hikes totalling 100 bp (consensus is 150 bp). In 2018, we expect the BCB to be on hold due to the recent BRL depreciation despite the central bank’s forward guidance at the March meeting suggestion a rate cut. In sum, our view on the BCB limits the upside for the BRL for 2018.”

“Longer out on the horizon, we still see limited upside in the BRL due to the above-mentioned vulnerability in public finances and political instability as well as the dependence upon commodity prices. However, increasing inflation pressure should impose the BCB to hike rates in 2019. This will in turn attract foreign investors and give some support to the BRL.”