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  • Biggest Rate Rise in Brazil for Years

    2010 - 05.11

    After the increase last week failed to tame rising inflation expectations Brazilian traders are betting for the first time on the central bank raising the benchmark lending rate by 1% point next month.

    Since central bank President Henrique Meirelles raised the overnight Selic rate by a bigger than predicted 75 basis points from a record low 8.75% on April 28th, the futures were raised by 14 basis points. In addition yields on overnight interest rate futures contracts due in July climbed two basis points (0.02 percentage point) to an 11 month high of 9.7%.

    In a central bank survey published last week economists are driving up their year end inflation forecast for a 15th straight week, which has led to bets on the first full percentage point increase since Meirelles’s second month in office in 2003. Since November the median estimate has risen from 4.25 percent to 5.42 percent. This is above the bank’s 4.5% annual target, reflecting the quickening expansion in Latin America’s biggest economy.

    “The front end of the curve has just blown out,” said Ram Bala Chandran, a Latin America currency and rates analyst at Citigroup Inc. in New York. “The momentum is so strong that it’s hard to step in front of it. As long as inflation is on the rise, the central bank has to go after it.”

    The national statistics agency said last week that industrial production soared by 20% in March, which is the biggest increase since records began in 1991. According to the central bank survey Brazil’s economy will grow by 6.1% this year with banks boosting loans by 17% in the month from a year ago to a record $840 billion (1.45 trillion reais).

    In a Bloomberg survey of economists Meirelles’s interest rate increase last week topped most of their predictions. Last month the Selic was held at 8.75% in a move that surprised economists, who had forecast an increase. Inflation has accelerated to an 11 month high of 5.2% in the year though mid-April.

    “The mood in Brazil is that activity is very, very strong, and the central bank is behind the curve,” said Ures Folchini, executive vice-president of local markets at the Brazilian unit of WestLB AG in Sao Paulo. “The market is confused about the next move.” He said he’s sticking to his 75 basis-point increase forecast at the June 10 policy meeting as “the market is overshooting.”

    The biggest threat to Brazil’s real is concern on Greece’s credit crisis spreading to other European countries and driving away investors from higher yielding assets.

    The real  posted a 33% advance in 2009 becoming the world’s best performing currency. Nelson Barbosa, the Finance Ministry’s secretary for economic policy told lawmakers in Brasilia that the government might have to take extra steps to control the real if it observes ‘excessive appreciation’. This was confirmed by Guido Mantega, the Finance Minister, who said that the government plans to make the exchange rate less volatile in order to aid growth. To do this he said that the government would be announcing new measures to help boost exports and these might include tax breaks.

    A week after Meirelles left the overnight rate unchanged yields began rising on the July futures contract on March 24th. Since then it has risen 59 basis points from 9.11%. Compared to inflation linked notes, Brazil’s fixed rate bonds are yielding the most in the past two years where there has been concern that consumer price increases will accelerate. Since the inflation linked notes were sold in January 2008 the gap between yields on the two securities due 2013 expanded to 613 basis points. The so-called breakeven rate reflects expectations for average inflation during the period.

    “The shift is taking place,” said Guillermo Mondino, head of Latin American research at Barclays Capital in New York. “We think they will do 75 basis points, but the market is likely to be positioning for a more aggressive hike. Activity has been very strong.”

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