Emerging Markets: Bank of Brazil Guides Monetary Policy Agenda

By Richard Cox

The Brazilian economy is one of the fastest-growing economies in the world and the base trajectory that is seen in GDP performance is often used as a gauge for emerging market economies as a whole.  At a recent policy meeting, the chief of the Bank of Brazil, Ilan Goldfajn, said that the central bank is working to decrease bank lending spreads to create an environment that would lead to lower interest rates in the long term.

Some of these plans include regulatory changes to help credit guarantees and lower the amount of subsidized lending in Brazil. He said, “Our objective going forward is to have credit growing along with the rest of the economy, in a sustainable way over time (Reuters).”  This stance should influence regional economies in the months ahead.

Impact on Forex Markets

Brazil has one of the largest interest rate spreads in the world, with their non ear-marked loans reaching 40.2% in December.  Factors like these could influence carry trades into the second half of this year if forex traders start to look at peripheral economies as a means for gaining carry value in their positions, and this could result in higher volumes in trading platform activity over the next few months.

In reaction to a strengthening recession, the central bank increased its pace of rate cuts to try and slow down the damage. in mid-January.  As a result, the benchmark Selic rate has been cut from 13.75%-13%. This is the latest action after the bank started the easing cycle with a quarter point cut in October and a quarter point also in November.

Forex Price Chart: US Dollar vs. Brazilian Real (USD/BRL)

The bank released a statement saying inflation is slowing more quickly and this is compatible with faster monetary easing (WSJ). The bank also warned the recession noted the economy has been slower than expected, and recovery could be delayed further.

One small surprise and unknown factor after the bank’s statement was they chose not to comment on the Trump administration’s potential policies and their effect on Brazil. This is a question mark the bank may choose to comment on only when more is known about what the new administration in the United States will be able to successfully pass.

Brazil’s Inflation Projections

The WSJ reported current projections for inflation in Brazil will end the year at 4.8% (the lowest since 2010). Gross domestic product was lower by approximately 3.5% in 2016, following 3.5% in 2015 (WSJ). This combination of slower inflation and poor growth “is at the core of the central bank’s monetary policy decisions” according to Rogerio Mori, an economist at the Getúlio Vargas foundation in São Paulo.

He went on to predict the rates will almost certainly go down, but the intensity and timeline will be based on upcoming inflation metrics. It should be noted the effect may be delayed because these measures will not provide immediate relief for families who have accumulated substantial debt during this severe recession.

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