Brazil Rate Increase Seen Lifting Real as Stock ETF Falls

Brazil’s surprise interest-rate increase will strengthen the real and boost investor confidence in the central bank, according to Goldman Sachs Group Inc.

The Brazilian currency is poised to appreciate today after policy makers raised the benchmark Selic rate by a quarter-point to 11.25 percent, Alberto Ramos, the chief economist for Latin America at Goldman Sachs, said by phone. Concern higher borrowing costs will restrain economic growth may weigh on stocks, according to IG Asia Pte Ltd. An exchange-traded fund investing in Brazilian equities fell 0.5 percent in Tokyo.

Policy makers said the rate increase, predicted by just one of the 54 economists surveyed by Bloomberg, would reduce the cost of ensuring a better inflation outlook in 2015 and 2016. Volatility in Brazilian assets has surged this week, with the real touching a nine-year low and the benchmark Ibovespa stock index briefly falling more than 20 percent from this year’s high, after President Dilma Rousseff won re-election.

“It does much to re-establish credibility,” said Ramos, who predicts further increases in the Selic rate to between 12 percent and 12.5 percent.

The real was little changed at 2.4619 per dollar yesterday after falling 4.1 percent this year, while the Ibovespa declined about 2.5 percent. The NEXT Funds Ibovespa Linked ETF dropped today for the first time in three days.

Stronger Real

The decline in the ETF is a “knee-jerk reaction,” said Ryan Huang, a strategist at IG, from Singapore. The government has a “tough job” as high borrowing costs could impact the growth of the economy, he said.

The economy contracted 0.6 percent in the second quarter after shrinking a revised 0.2 percent during the first three months of the year. Investment dropped 5.3 percent on the quarter, while services and industry also shrank.

The central bank’s move will probably boost rates on short-term debt while reducing those on longer-maturity notes as inflation projections decrease, leading to a flatter yield curve, according to Bruno Rovai, an analyst at Barclays Plc in New York.

“Markets were already pricing rates hikes in the next four meetings, nevertheless, we expect to see the short-term section of the yield curve moving up,” Rovai wrote in an e-mailed note.

Policy makers are trying to head off the potential for rising consumer prices caused by a weakening real, according to Ramos. Inflation in the month through mid-October accelerated to 0.48 percent from 0.39 percent a month earlier, while the annual rate held at 6.62 percent. The central bank targets annual inflation of 4.5 percent, plus or minus two percentage points.

“These are the small steps that can go a long way,” Ramos said. “The real will trade stronger.”

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