Brazil Swap Rates Rise on View Tax Cuts Won’t Work; Real Gains

Brazil’s shorter-term swap rates rose on speculation the government’s latest tax breaks will fail to contain inflation, prompting policy makers to increase benchmark borrowing costs.

Swap rates on the contract due in July 2014 climbed three basis points, or 0.03 percentage point, to 8.16 percent. The real appreciated less than 0.1 percent to 2.0208 per U.S. dollar.

The Finance Ministry said March 30 that it would extend to December a reduction of the so-called IPI tax on vehicles that was due to expire today. The central bank said last week that inflation has spread, boosting the probability that price increases will breach the upper limit of the target range for the first time in a decade.

“What’s reverberating in the market is this extension of the IPI tax for the automotive sector,” Jayro Rezende, the head of the derivatives desk at CGD Investimentos in Sao Paulo, said in a telephone interview.

Brazil’s government has extended payroll tax cuts to new industries, reduced electricity costs and eliminated federal taxes on food staples to cushion Brazil’s economic recovery while taming consumer price increases.

Swap rates on longer-term contracts fell today after a report showed U.S. manufacturing grew less than forecast in March, dimming external factors that support Brazil’s growth.

Inflation View

Policy makers estimate there is a 25 percent chance Brazil’s inflation will exceed 6.5 percent this year even under a scenario in which they raise the benchmark interest rate to 8 percent from a record low 7.25 percent, according to the quarterly inflation report published last week. In December, they saw a 14 percent chance of breaching the inflation ceiling. They reduced the 2013 economic growth forecast to 3.1 percent from 3.3 percent.

The currency rose on March 27 for the first time in seven days as the central bank announced the sale of foreign-exchange swaps to curb the real’s declines in its first intervention since March 11.

The central bank has swung between selling currency swaps to prevent the real from falling too quickly and offering reverse currency swaps to protect exporters by preventing excessive gains. The real closed at a 10-month high of 1.9442 per dollar on March 8 before the central bank intervened on March 11 to weaken it.

“The central bank could intervene depending on the real’s course,” Darwin Dib, the chief economist at CM Capital Markets Asset Management in Sao Paulo, said in an interview.

Minutes of the central bank’s March 5-6 meeting indicated that an increase in the target lending rate from a record low wasn’t imminent as policy makers said “a cautious management of monetary policy” was needed. The monetary policy committee will next meet April 16-17.

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