Brazil Central Bank Likely to Keep Rates On Hold

Brazil's central bank will probably keep its benchmark interest rate unchanged at 11.25% today for a third straight meeting as policy makers gauge whether the recent acceleration in inflation is sustained. Against the backdrop of rising prices and Brazil's fastest growth since 2004, central bank President Henrique Meirelles decided on Oct. 17 to pause after a string of 18 straight cuts, the longest cycle of easing since Brazil adopted inflation targets in 1999.

Brazil's overnight rate has fallen by more than half over this period. The real interest rate, however, - or the difference between the 11.25 percent Selic benchmark lending rate and 4.46 annual inflation - is the sill highest in Latin America at 6.79 percent.

Policy makers will probably take the view that a worldwide economic slowdown will reduce Brazil's inflation rate by cutting demand for commodities, even after consumer prices jumped the most in more than two years in December. Inflation accelerated to 0.74 percent last month, led by food, the fastest pace since October 2005.




Rather than raising the central bank is much more likely to say that it will continue to monitor inflation to see whether it threatens its 4.5 percent target.

On the other hand, traders are forecasting higher rates. The yield on the interbank deposits future rate contract due January 2009 traded at 11.97 percent yesterday, above the current Selic rate.

Capital Flows Into Brazil

The following article from the Financial Times provides more information and details on this process:

Brazil surprises with surge in foreign cash

Barely a day goes by in São Paulo, Brazil’s biggest city, without news of more foreign investment, and this week has been no exception.

Anglo American, the mining giant, said on Thursday it would pay $5.5bn (€3.7bn, £2.8bn) to buy control of two iron ore mines from Brazilian company MMX. And a couple of days ago, news emerged that Symetrix, a US chip company, was investing $1bn to make smart cards.

Flows of foreign direct investment are surging. For much of this decade Brazil’s attractions have paled beside those of other gigantic emerging markets, China, India and Russia, hitherto the most rapidly growing of the BRIC countries. But in the past few months Brazil has begun to do better.

Figures published last week by the United Nations Conference on Trade and Development showed Brazil won twice as much foreign direct investment as India in 2007 and its investment grew at a faster rate than that of Russia or China.

Total flows of $37.4bn were more than double the amount Brazil attracted in 2006 and also, in nominal terms at least, higher than flows attracted at the beginning of this decade when a privatisation campaign was in full swing.

Chinese investment dipped to $67.3bn compared with $69.5bn in 2006, while Russia brought in $48.9bn, 70 per cent more than in 2006.

“It was a surprise,” says Antonio Côrrea de Lacerda, an economist with Sobeet, a Brazilian think-tank on transnational companies, who had been expecting Brazil to attract only about $25bn. “The rest of the world is growing but Brazil is now getting a good share of the increase.”

Why has Brazil been doing so well? Part of the story is that the country is rich in the natural resources – such as oil, soya beans and iron ore – for which world demand has been growing. In the first 11 months of 2007, Brazil attracted $3bn into its mining sector, almost six times as much as in 2006.

The recent investment success is much broader, however. Central bank figures for the first 11 months show that more than a third of overall inflows have been directed to manufacturing.

Brazil’s highly competitive steel industry is one focus. Lakshmi Mittal, president and chief executive of Arcelor Mittal, the world’s biggest steel company, is an enthusiast.

Last year, he oversaw a big expansion at his company’s Tuburão complex and in December made a $1.75bn offer to buy the 43 per cent stake Arcelor Mittal did not already own in Acesita, a stainless steel maker.

Mr Mittal plans to spend another $5bn over the next five years to increase annual capacity by more than 40 per cent.

Billions of dollars have been pumped into the ethanol sector, where Brazil’s experience and technical expertise is an important advantage.

As Andrew Liveris, chairman and chief executive of Dow Chemical, explains: “When it comes to biofuels and related products, Brazil is the leader. The US is thinking about it. Brazil is doing it.”

But much of the interest is related to Brazil’s own im-proving macroeconomic prospects. Cautious monetary and fiscal policy has stabilised the economy and paved the way for a steady expansion of domestic credit.

Sectors oriented to the domestic market, such as construction, are surging. Growth, which reached 5 per cent in 2007, is disappointing compared with that of China or India, but investors are increasingly confident that the wider domestic demand and rising rates of capital formation will allow Brazil to survive a slowdown in the US economy relatively unscathed.

Yet even some who are investing in Brazil express concern about obstacles to growth.

Marcelo Mosci, head of GE for Latin America, says failure to improve business conditions through labour and other reforms will create trouble ahead. “There are two Brazils. Investment is growing, the private sector is doing a terrific job. But [because of lack of reform] Brazil is hitting a big road block,” he says.

For the moment, none of this is denting enthusiasm. As Emy Shayo, an economist with Bear Stearns, puts it: “People are totally in love with Brazil. Investors come here and they think it is the best country in the world.”

Brazil Inflation December 2007

Brazil's consumer prices rose at the fastest inter-monthly rate in over two years last month, making it harder for the central bank to further cut Latin America's highest benchmark lending rate. Consumer prices, as measured by the IPCA index, jumped 0.74 percent in December, the biggest increase since October 2005, the national statistics agency said. The gain, fueled by food prices, was almost twice the 0.38 percent increase in November and pushed the annual rate to 4.46 percent.



Higher food prices accounted for most of the inflation increase, climbing 2.1 percent in December, the biggest gain since January 2003. Food prices climbed 10.8 percent last year and were responsible for almost half the increase in the annual rate, which accelerated for the first time in five years.

The central bank ended a two year cycle of interest rate cuts on Oct. 17 2007, after inflation began to accelerate. With both economic growth and annual inflation picking up speed, the central bank is unlikely to make further reductions to the overnight rate, which is already at a record low of 11.25 percent, and may be forced to raise rates at some point this year.

Brazil's central bank targets annual inflation of 4.5 percent. A plus or minus 2 percentage point range can be used to accommodate unexpected price shocks. ABN Amro expects inflation to quicken to 4.8 percent this year, up from an earlier forecast of 4.3 percent.

The real gained 0.5 percent to 1.7501 per dollar at 12:15 p.m. New York time yesterday, following a gain of 20 percent last year.

Inflation and Interest Rates

Brazil's real rose again yesterday after Federal Reserve Chairman Ben Bernanke signaled the U.S. central bank may cut interest rates further this month to shore up growth in the world's largest economy. The real rose 0.6 percent to 1.7570 per dollar at 2:26 p.m. New York time after weakening as much as 0.2 percent earlier.

The outlook for lower interest rates in the U.S. makes Brazilian domestic fixed-income assets more attractive. Brazil's real interest rate, or the difference between the central bank's 11.25 percent benchmark lending rate and the country's 4.19 percent annual inflation, is 7.06 percent, the highest in any emerging market. In the U.S., the benchmark borrowing cost is 4.25 percent and on its way down, since Bernanke's comments have greatly increased speculation the policy- setting Federal Open Market Committee will cut the federal funds target by a half-percentage point on Jan. 30.

``Additional policy easing may well be necessary'' to offset ``downside risks'' to U.S. growth, Bernanke said in his first speech on the economy since the Fed's Dec. 11 meeting. Lower interest rates may be required ``in light of the recent changes in the outlook for and the risks to growth,''

Yields on Brazil's zero-coupon bonds rose on speculation Brazil's IPCA consumer price index will probably show inflation accelerated more than economists forecast.

The Real Slips a Little

Brazil's real fell yesterday on concern that the latest U.S. jobs report signals the U.S. economy may slip into a recession, reducing demand for Brazilian exports and local financial assets. The real fell 0.2 percent to 1.7547 per dollar at 1:30 p.m. in New York after rising 1.1 percent earlier. The currency gained 20 percent against the dollar in 2007, which was the the biggest advance among the 16 most-actively traded currencies.

The vlaue of the real has been rising on the back of record sales abroad and growing interest in Brazil's high-yielding bonds following the sub-prime bust.

Brazil's benchmark stock index, the Bovespa Index, fell as much as 3.7 percent at one point.

The yield on Brazil's zero-coupon bonds due in January 2009 rose 10 basis points, or 0.1 percentage point, to 12.08 percent, according to Banco Votorantim SA.


Despite the slowdown in global growth that we'll see this year, Brazil may well be one of the emerging economies whioch is able to decouple to some extent from the path of the G7 economies. At least that is the idea which will be put to the test in 2008.

The outlook for the maintenance of Brazil's 11.25 percent benchmark lending rate to fend off inflationary pressures also favors the real while the U.S. overnight lending rate may fall below 4 percent in the not to distant future.

Brazil's central bank bought U.S. dollars in the spot market yesterday as part of a strategy to slow the currency's appreciation. The bank bought dollars at 1.7590 reais apiece at auction. The bank has bought dollars on an almost basis daily since Oct. 8.