It's hard to make predictions on Brazil these days. Anything goes, and so much of it depends on the direction of the dollar and the Chinese economy. China is Brazil's No. 1 trading partner.
But for market consensus that now thinks Brazil is finally done hiking interest rates because inflation is finally done rising, prudence is everything. Who says inflation can't hit 9%? It's currently at 8.89%, and has been rising steadily since April. In fact, it's been rising all year, despite a 200 basis points hike since Jan. 21.
Brazil's Central Bank hiked the policy rate by 50 bips on Wednesday night to 14.25%. If they're done, it will depend on inflation, not the currency, which continues to weaken to over R$3.30 to the dollar. Unfolding news in the ongoing political saga in Brasilia has destroyed sentiment in Brazil, coupled with a stronger dollar and perception that China's stock market collapse over the last several weeks is a downer for Latin America's biggest economy.
On the hike, the monetary policy committee was unanimous in its decision to hike rates yet again, the fourth time this year and the seventh hike since November.
With this increase, the policy rate in this hiking cycle has now risen by 325 basis points since October. The policy committee stayed put in November with rates at 11.25%.
Joao Pedro Ribeiro, a fixed income analyst for Nomura Securities in New York, thinks the bank has likely reached the end of its hiking cycle. But "likely" is the operative word here. Inflation will dictate this direction. There is a chance that inflation will come down in the months ahead now that price stabilization has set in for the regulated sector hikes that occurred this year with gasoline and electricity.
However, the monetary policy committee's statement said the outlook for inflation was the key reason for hiking, meaning we could crash through 9% soon. Seeing that inflation has been stubborn in its trajectory, a 9%+ inflation period of a month is just as likely to lead to a rate hike before the end of the year. If rates do not rise, and inflation does not fall below 8%, then rates will remain in the 13.5% to 14.5% range until the Bank sees inflation come down to earth. They Bank is more interested in fighting inflation right now than promoting growth through cheaper capital costs.
Can Brazil Grow With High Interest Rates?
While it is understandable that businesses prefer cheap capital for growth, they also prefer some predictability with inflation and price discovery. Brazilians are more fearful of hyper-inflation than they are of high interest rates, which is something they have lived with for generations, even when rates fell to 8.7% between September 2009 and March 2010.
Between 2000 and 2007, the height of the commodity and liquidity bubble that helped Brazil become a middle class society, interest rates nearly 19% and never fell to where they are today until 2006, when they started a steady two year decline.
Brazil artificially lowered interest rates during the Great Recession in an attempt to scare of currency speculators looking for yield. Brazil's currency, the real, was trading at R$1.55 to the dollar then, at a time when the economy was slowing and its most important market, China, had singled handedly destroyed Brazil commodity market.
Brazil investors will be waiting for next week's meeting minutes from the policy crew.
If the reading shows that keeping the benchmark Selic rate at 14.25% is a necessary, but not sufficient condition to fight inflation, there could be space for another hike in September, especially if the currency continues to depreciate on the back of the political noise.
President Dilma Rousseff is effectively fighting off a coup within her Workers' Party allies, the Democratic Movement Party, or PMDB. The PMDB hold the lead role in the Senate and Lower House of Deputies, as well as the Vice Presidency. Veep Michel Temer recently told a gathering at Columbia University in New York that his party would break with Dilma's party in the next presidential election. That is akin to saying the party is no longer in Dilma's camp and looking for an out. The woman has no support.
For now, Finance Minister Joaquim Levy is running the show and he is hell bent on austerity, removing temporary tax cuts put in place under Guido Mantega, his predecessor.
Meanwhile, the Bank's chairman Alexandre Tombini is being allowed a greater degree of autonomy, hiking rates at a time when Brazil is in a recession.
For Tombini, inflation is public enemy number one. Not PMDB. Not China. Not the Fed and the U.S. dollar.
"Most likely the monetary policy committee's models still do not show inflation at the mid-point of the target for 2016," says Bruno Rovai, a fixed income analyst for Barclays Capital in New York.
Nevertheless, growth slowdown and rising unemployment means the conditions to lower inflation are now locked in. Less demand means lower prices, at least for some items.
BarCap is longer expecting a hike at the September meeting. But Brazil interest rates will only start falling by March 2016. And that is only if inflation cooperates.
