Brazil's Real Drops to Four-Month Low as SocGen Predicts Record

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  • Most economists in Bloomberg survey expected bank to lift rate
  • Shift fuels concerns about central bank independence, policy

Brazil’s real sank to a four-month low and bond traders priced in faster inflation after the central bank’s surprise decision to keep interest-rates unchanged raised questions about the institution’s independence.

Deutsche Bank AG, Brown Brothers Harriman & Co. and Credit Suisse Group AG all issued reports signaling concern that policy makers are under political pressure to prioritize economic growth over fighting inflation. Societe Generale said the real seems poised to drop about 6 percent more to a record 4.4 per dollar within weeks.

While forecasts for Brazil’s deepest and longest recession in more than a century could justify a decision to keep interest rates unchanged, the central bank didn’t communicate its strategy clearly in the weeks leading up to the meeting and that’s stoking concern its coming under political influence, said Nicholas Spiro, a London-based managing director at Spiro Sovereign Strategy. An unusual statement from the monetary authority Tuesday that it was taking new growth forecasts into account came just days after the bank’s president sent an open letter to the government reiterating his commitment to slow inflation to 4.5 percent in 2017, from the current level of more than 10 percent.

"Brazil’s central bank has made it crystal clear now that it’s more concerned about the severity of the economic downturn than the sharp rise in inflation," Spiro said. "This would be a perfectly defensible view if it were not for the fact that monetary policy has become dangerously politicized and that the central bank was, up until very recently, sounding quite hawkish."

The real dropped 1.4 percent to 4.1552 per dollar in Sao Paulo, the weakest closing level since Sept. 23. Swap rates on contracts maturing in January 2017, which show traders’ expectations for borrowing costs, fell 0.26 percentage point to 14.885 percent, the lowest level in four months. The breakeven rate, a measure of bond traders’ expectations for inflation over the next two years, rose 0.3 percentage point to 10.66 percent, the highest in at least three years.

“The signaling process orchestrated by the monetary authority has lost some of its power to coordinate market expectations,” Credit Suisse economists led by Nilson Teixeira wrote in a report. “It will make it even more difficult to bring about a significant reduction in consumer inflation in the coming quarters.”

Late Wednesday, policy makers said they would keep the benchmark Selic rate at 14.25 percent, surprising economists surveyed by Bloomberg, most of whom had expected at least a 0.25 percentage point increase. The bank cited global uncertainty for the decision, which came a day after the International Monetary Fund cut its estimates for Brazil’s economy, forecasting a 3.5 percent contraction this year and zero growth next year. That would mark the longest period without expansion in more than a century.

Suspicions of political influence over the central bank come as President Dilma Rousseff works to overcome an effort to impeach her for alleged accounting violations related to government finances and boost record-low popularity numbers. Lower borrowing costs can aid growth by making it more attractive for businesses to take out loans and invest.

Bernd Berg, an emerging-markets strategist in London at Societe Generale, said the currency will come under further pressure because of the central bank’s move. A drop to 4.4 per dollar is possible in the next couple of weeks if global sentiment continues to deteriorate and commodity prices remain at historic lows, he wrote.

Win Thin, the head of emerging-market strategy at New York-based Brown Brothers, said the rate decision was “terrible.” He predicted the currency would soon weaken past its record low of about 4.25 per dollar, reached in September.

“This is a major blow to the BCB’s credibility, especially considering that the bank has not been able to keep inflation close to the 4.5 percent target since 2009,” Deutsche Bank strategists led by Drausio Giacomelli wrote in a report. “The BCB decision not to raise interest rates seems to be consistent with a broader strategy of trying to stimulate an economic recovery at any cost due to political reasons.”

Credit-rating downgrades to junk, the economic slump and a deteriorating fiscal outlook helped push the real down 33 percent last year, the most among the world’s 16 most-traded currencies.

The monetary committee’s "hesitant monetary strategy, particularly versus the very recent more decisive hawkish signals and guidance, is beset with significant risks as it will likely be perceived as a weak monetary response to the very challenging inflation outlook," Goldman Sachs Group Inc.’s senior economist Alberto Ramos wrote in a note to clients.

"Furthermore, the chosen strategy may lead to additional pressure on the BRL and further unmooring of inflation expectations, which may eventually require a deeper and longer hiking cycle down the road," Ramos said.