Coronavirus fears have created a dilemma for Brazil’s Central Bank

. Mar 04, 2020
Coronavirus fears have created a dilemma for Brazil’s Central Bank Photo: EBC

After the U.S. Federal Reserve slashed interest rates by 0.5 percentage points to mitigate the impacts of the coronavirus outbreak on the U.S. economy, investors immediately predicted a similar move by Brazil’s Central Bank. On March 18, when both the Fed and Brazil’s Monetary Policy Committee are set to have policy meetings, the expectation of further interest rate cuts is already dictating stock prices—but economists are unsure whether more cuts will have much of an effect on the Brazilian economy at this point.

The night after the Fed’s

first emergency decision since the 2008 financial crisis, investors’ bets were strengthened by a <a href="">statement from the Central Bank</a>, saying it is &#8220;closely monitoring&#8221; the impacts of the coronavirus on finances and the Brazilian economy. It added that “the impact of the global slowdown on the Brazilian economy tends to dominate an eventual deterioration in financial assets’ prices,” but that the next two weeks will provide data on how this may affect inflation, and consequently, monetary policy.</p> <p>For investors, that sounded like an “open door for more stimulus packages to come,” as Itaú BBA&#8217;s research team <a href="">wrote to its clients</a>. If this forecast does come to pass, it would mark a change from the committee’s recent decision to halt the monetary easing cycle that has brought Brazil’s benchmark interest rate to its lowest level ever: 4.25 percent.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/1872786" data-url=""><script src=""></script></div> <p>Camila Abdelmalack, an economist at Veedha Investimentos, believes that the Central Bank was justified in its remarks, saying that other monetary authorities besides the Fed, such as the Bank of Canada, were also slashing interest rates. However, she is skeptical of the benefits such a measure would create for Brazil.</p> <p>“I don’t think we are as exposed as other economies to the economic impacts of the coronavirus outbreak. I believe it is limited to the short-term and I don’t think it will harm the economic activity for the year,” she told <strong>The Brazilian Report.</strong> “I see a chance of a 25 base point interest rate cut, but I don’t think it will help in terms of [economic] activity.”</p> <p>Indeed, economists were expecting a cut even before the Fed’s decision, and some have advocated for even more aggressive measures. <a href="">XP Research</a> believes a 50 base point cut is on the cards for March 18; Goldman Sachs expects the rate will see out the year at 3.75 percent, while brokerage Necton sees it at 3.25 percent, according to <a href=""><em>O Globo</em> newspaper</a>.</p> <p>Even before the weak 1.1 percent GDP results released by official statistics bureau IBGE on Wednesday, economists had slashed Brazil’s growth estimates for 2020, as we explained in our article on <a href="">Brazil&#8217;s struggles to regain growth</a>.&nbsp;</p> <p>The government is also set to revise its growth projections for the year, but will not go &#8220;below the 2-percent level,” according to <em>Reuters</em>. Later on Wednesday, <a href="">Economy Minister Paulo Guedes said</a> the country may grow above that threshold “if [economic] reforms are approved.”</p> <h2>Immediate impacts</h2> <p>The foreign exchange rate in Brazil reached BRL 4.58 against the U.S. Dollar on Wednesday—a new record nominal low—in spite of regular swap auctions by the Central Bank. The local currency rose briefly after an announcement of 20,000 new swap contracts to be auctioned on March 5, to end the day on a slump of 1.5 percent. Since January 1, the Brazilian Real has lost almost 13 percent of its value, being among the worst-performing currencies in the world.</p> <div class="flourish-embed flourish-chart" data-src="visualisation/1509234"><script src=""></script></div> <p>This rout has spurred criticism of the Central Bank on social media, as well as political pressures on the government. Some analysts believe the interest-rate cut by the U.S. provides an opportunity to prop up the Brazilian Real, if the Central Bank sticks to its guns and stops slashing its own interest rates. That’s because a wider difference between Brazilian and U.S. interest rates could make local assets more attractive to foreign investors—a phenomenon typically known as “carry trade”—increasing the influx of dollars into Brazil. However, the Central Bank’s recent statements appeared to suggest a different path.</p> <p>For Sérgio Machado, managing partner at Trópico Investimentos, the comments helped to put pressure on the Brazilian currency. “If there is another interest cut in Brazil, only those who were already gambling on another wave of cuts will benefit, it’s like a circular effect. The most impressive thing is that it is not reaching credit and economic activity. Once again, the Central Bank is held hostage by the market,” he told <strong>The Brazilian Report.</strong></p> <p>In his view, the Central Bank changed its view on foreign exchange since January, considering that a weaker Real would be acceptable, but it was caught out in the middle of the process by an unfavorable foreign scenario and took too long to act. “The longer you wait, the less effective the remedy is. Though they announced a big operation with swaps, it wasn’t effective.”</p> <p>As a result, Mr. Machado sees an upwards trend for the Brazilian Real in the near future. While many analysts point out that there’s still room for inflation to rise, he warns that the exchange rate may be putting pressure on prices. “I don’t see a comfortable inflation scenario because wholesale prices are pressured. This is not an easy situation”, he said.

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Natália Scalzaretto

Natália Scalzaretto has worked for companies such as Santander Brasil and Reuters, where she covered news ranging from commodities to technology. Before joining The Brazilian Report, she worked as an editor for Trading News, the information division from the TradersClub investor community.

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