LCA Weekly Macro View: Brazil Central Bank is expected to interrupt the monetary easing cycle by year-end, as rising global bond yields start to weigh on the Brazilian currency

LCA Weekly Macro View: Brazil Central Bank is expected to interrupt the monetary easing cycle by year-end, as rising global bond yields start to weigh on the Brazilian currency

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Chamber Member News Post Date: 11/15/17 Source: LCA Consultores By: LCA Consultores
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Summary

The Brazilian currency (BRL) has been under some pressure in recent days. The US Dollar (USD), which had been fluctuating at around BRL 3.10 until the beginning of this 4th quarter, has remained closer to BRL 3.30 in recent weeks. Although the internal political scenario is still clouded - with the constant comings and goings about the possibility of approving reforms, especially social security reform, and the persistence of great uncertainty regarding the electoral scenario for 2018 -, we consider that the recent depreciation of our currency is mostly associated with external factors.

The main external factor behind the moderate depreciation of the BRL seems to be the recent rise in global bond yields - a movement that is largely associated with the incipient withdrawal of monetary stimulus by the main central banks of advanced economies, in a context where global growth is gaining traction. In these circumstances, the appetite of global investors for higher risk assets tends to regress gradually, exerting some pressure on emerging currencies.

Two other factors seem to be also putting some pressure on emerging currencies: (i) the prospect of approval by the US House of Representatives of Donald Trump's proposed tax reform - which has been supporting the USD in global exchange markets; and (ii) signs of a slowdown in the Chinese economy in this 4th quarter, as retail sales, industrial production and investment in fixed assets showed weaker results in October.

Our base case scenario continues to anticipate that the pressure on the BRL will tend to become moderately more intense in 2018, when: (i) the withdrawal of monetary stimulus in the central economies will advance at a somewhat faster rate, with higher interest rates and a reversal of the asset purchase policies; and (ii) the internal political scenario may exert more pressure associated with electoral uncertainties.

Thus, we continue to forecast a more depreciated domestic exchange rate in the average of 2018, compared to the average estimated for 2017. Our base case scenario anticipates a rise in the average annual price of the US Dollar from around BRL 3.20 estimated for this year to around BRL 3.40 projected for the coming year.

In our view, this moderate exchange rate depreciation - both the recently observed and the one we project for 2018 - tends to make it less easy to meet next year's inflation target. Indeed, inflation seems to have bottomed; and, when seasonally adjusted, is already trending towards the 4.5% target for 2017 and 2018.

Thus, we continue to expect that the current monetary easing cycle will be interrupted at the end of this year, after a new cut of 50 basis points in the benchmark interest rate (the Selic). But the Selic is expected to remain at a historical low of 7% throughout the whole of 2018 (and perhaps 2019), once we expect a modest acceleration of economic activity in coming years (in a context of persistent political uncertainty), which should help to refrain inflation pressures. Read Full Article