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No Goodbye Rate Increase Spurs Traders’ Flip-Flop: Brazil Credit

Brazilian traders are scrapping bets that central bank President Henrique Meirelles will raise interest rates this week in the final meeting of his eight-year tenure, futures contracts show.

Meirelles’s decision Dec. 3 to increase bank reserve requirements squelched speculation he’d raise the benchmark rate from 10.75 percent to bring inflation down from a 20-month high of 5.5 percent. Rate-futures yields due in January sank 15 basis points on Dec. 3 to 10.69 percent, showing traders expect no change in rates at the Dec. 8 policy meeting. On Dec. 2, they were betting on an increase of at least 25 basis points.

The rule change, which will remove about 61 billion reais ($36 billion) from the economy, buys time for Meirelles’s appointed successor, Alexandre Tombini, to assess President-elect Dilma Rousseff’s fiscal plans before deciding on rate increases next year, said Luis Fernando Lopes, a partner who helps manage 1.1 billion reais at Patria Investimentos.

“A December rate hike is very, very unlikely,” Lopes said in an interview from Sao Paulo. “They still want this very important piece of information which is missing, namely what is fiscal policy in Brazil over the next years going to be.”

Annual inflation has accelerated above Brazil’s 4.5 percent target, fueled by credit growth, higher food prices and a 27 percent increase in government spending in the first nine months of the year. Investors on Nov. 26 started to bet the central bank would raise rates in December as inflation quickened.

Spending Outlook

The government plans to cut funding for its state development bank by 50 percent next year and freeze new spending initiatives to help the central bank contain inflation, Finance Minister Guido Mantega said in an interview Nov. 30. Rousseff has pledged to cut net public debt while saying she’ll boost payouts to the poor and may raise the minimum wage more than planned.

A spending cut equivalent to 1 percent of gross domestic product would slow inflation by 0.32 percentage point, according to the median estimate of economists in a central bank survey published Nov. 8.

Meirelles raised bank reserve requirements on time deposits on Dec. 3 to 20 percent from 15 percent and the requirement for non-interest bearing accounts to 12 percent from 8 percent to slow consumer lending. The reserve measures are designed to curb liquidity in the financial markets and prevent credit “bubbles,” Meirelles told reporters in Brasilia on Dec. 3. Lending is expanding at a 20 percent annual pace.

Starting to Act

“This measure is more effective than a rate hike because it focuses on the credit side that has been quite strong,” said Marcelo Saddi Castro, who oversees 18 billion reais as chief investment officer at SulAmerica Investimentos in Sao Paulo. “The central bank has started to act -- that’s good news.”

While traders are ruling out a December rate increase, they are boosting wagers for higher borrowing costs in January, a view both Patria’s Lopes and SulAmerica’s Castro share.

The contracts maturing in February suggest traders expect the central bank will raise the rate to 11.25 percent next month after Tombini takes over. His nomination to lead the central bank is subject to approval in the Senate.

At 12.05 percent, the yields of contracts due in January 2012 suggest the so-called Selic rate will end the next year at about 12.75 percent. The central bank has held the rate steady since July after boosting it this year by 200 basis points, or 2 percentage points, to cool an economy that is growing at the fastest pace in more than two decades.

January Increase

The increase in reserve requirements is a sign that the central bank is ready to raise interest rates in January and policy makers will prepare the market participants for it at the Dec. 7-8 meeting, according to Itau Unibanco Holding SA, Latin America’s biggest bank by market value, and JPMorgan Chase & Co.

“The policy signal is clear-cut: The tightening cycle has started,” Fabio Akira Hashizume, an economist at JPMorgan in Sao Paulo, wrote in a report to clients. JPMorgan pushed forward its forecast for a rate increase to January from April.

All but three of 35 economists surveyed by Bloomberg forecast the central bank will keep the rate steady at 10.75 percent at the end of the two-day meeting on Dec. 8. Jose Marcio Camargo, an economist with Opus Gestao de Recursos Ltd., and Zeina Latif, a senior economist with RBS Securities Inc., forecast a half-percentage-point increase and Andre Perfeito, chief economist at Gradual Investimentos, predicted a rise of a quarter point.

Policy makers need to raise interest rates this week because the central bank is at risk of losing control of inflation expectations, said Camargo, one of the only two economists surveyed by Bloomberg who correctly predicted the central bank’s policy decision for each of the meetings since March.

‘No Benefits’

“If the central bank is really convinced that they will have to increase interest rates in the near future, it is better to start it now than in January or February,” Camargo said. “There is no reason to wait -- only costs and no benefits.”

Putting off the increase will force the bank to raise borrowing costs by as much as 250 basis points next year to tame inflation, compared with just 150 basis points if they were to begin acting this month, according to Camargo.

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps increased 3 basis points Dec. 3 to 106, according to data compiled by CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Meirelles said today that Brazil’s credit rating is lower than it should be and is likely to be upgraded.

Credit Rating

“Looking at some European countries, Brazil’s rating seems a bit low,” Meirelles said in a speech in Sao Paulo. “But it’s only a question of time before this changes.”

An upgrade in the country’s credit rating depends on how the Rousseff government withdraws stimulus measures implemented during the global financial crisis, said Regina Nunes, the representative for Standard & Poor’s in the country.

The real strengthened 0.6 percent to 1.6775 per dollar at 2:02 p.m. New York time.

Brazil may take additional measures to stem gains in the real, after it imposed taxes on foreign fixed-income investors in October, Mantega said in Rio de Janeiro today, without giving more details.

Rousseff appointed former Finance Minister Antonio Palocci to be her Cabinet chief on Dec. 3. Palocci, while serving under President Luiz Inacio Lula da Silva from 2003 to 2006, crafted policies that reduced the budget deficit, helping cut the inflation rate from 17.2 percent.

“The government could spring a very positive surprise and announce important fiscal measures,” Octavio de Barros, chief economist at Banco Bradesco SA, wrote in an e-mailed response to questions. “There might not even be a hike in the Selic rate in January. The central bank and the government will speak the same language and there will be greater coordination of the monetary and fiscal policies.”

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