Itaú BBA - Central Bank intensifies FX intervention

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Central Bank intensifies FX intervention

September 2, 2013

The Central Bank announced a program of daily auctions in the FX market.

The Brazilian economy in August 2013

The Central Bank announced a program of daily auctions in the FX market, committing itself to a minimum volume of interventions through year-end. The Central Bank also increased the basic interest rate again, to 9.0%, signaling that this pace of rate increases will continue. The economy grew above expectations in the second quarter, but is likely to decelerate ahead. Inflation declined due to food and regulated prices. The current account deficit reached 3.4% of GDP, and the government primary surplus remained below this year’s target. The government’s approval rating showed some recovery in the latest polls.

The Central Bank announced a program of daily auctions in the FX market…

After a sharper depreciation of the real (which reached 2.45 per dollar), the government on August 22 announced a new auction program "with the aim of providing a foreign exchange hedge to economic agents and liquidity to the foreign exchange market." At least until the end of the year, daily USD 500 million auctions will take place, from Monday to Thursday. On Fridays, USD 1 billion of spot-dollar funding will be auctioned. If deemed necessary, the Central Bank will intervene further. This volume is equivalent to the sale of approximately USD 35 billion in swaps and USD 18 billion in spot-dollar funding. The real has appreciated since the announcement and closed the month at 2.37 to the dollar.

... and raised interest rates to 9.00%, signaling that it will maintain the pace of rate increases.

The Monetary Policy Committee (Copom) raised the monetary policy rate by 0.50 pp, to 9.00% per year, as widely expected. The statement accompanying the decision was like the one from the previous meeting, indicating that the Monetary Policy Committee will maintain the pace of rate hikes. The decision supports our forecast that the Selic rate will end 2013 at 9.75% pa. We expect an additional 0.50 pp hike in the next Copom meeting and a final 0.25 pp increase in November.

GDP grew above expectations, but is likely to decelerate ahead.

GDP rose 1.5% qoq/sa in the second quarter, with agriculture, services and taxes contributing to growth above our forecast. Industry confirmed the expectation of a strong increase and gained 2.0% over the first quarter. On the demand side, the highlight was the significant expansion of investment. Gross fixed capital formation grew by 3.6% in the quarter. Household consumption and government spending posted a slight expansion. The higher reading in the second quarter should slightly raise our estimate for the year (currently at 2.1%). However, it does not alter our forecast for an economic slowdown in the second half, or the prospect of a GDP close to 0% or slightly negative in the third quarter.

Inflation falls due to food and regulated prices.

The IPCA was only 0.03% in July, reducing the 12-month rate to 6.3% (from 6.7%). The improvement resulted from lower inflation on food and regulated prices. The upward pressures come from industrial goods, driven by the depreciation of the exchange rate, and from service inflation, which remains high as a result of a still tight labor market.

The current account deficit reached 3.4% of GDP...

The current account deficit increased again in July, after having shown signs of improvement in the previous month.  The 12-month rolling deficit amounted to USD 77.8 billion, or 3.4% of GDP. The trade deficit, driven by oil imports, was the main factor, but the larger service deficit was the main surprise. Foreign direct investment continues to show resilience, amounting to 2.7% of GDP. In portfolio investments, local fixed income investment was again the highlight, as it continues to react to the withdrawal of the IOF tax.

... and the government primary surplus remains below this year’s target.

The 12-month rolling recurring primary result, which excludes atypical revenues and expenses, is flat, at around 1.5% of GDP since March. We maintain our forecast at 1.7% for this year (below the 2.3% target), but we see growing risk of a weaker number, due to rapid spending growth, tax exemptions, subsidies to the Energy sector, and the deceleration of GDP from 3Q13 onwards.

Government approval rating shows some recovery.

According to surveys by IBOPE and Datafolha, the government’s approval rating rose to 36% and 38% respectively, after having fallen to 30%-31% in the July surveys. Some recovery was expected, since previous surveys had been conducted on dates close to the country-wide street protests. Still, government approval stands at levels well below those reached before the demonstrations (57%).

The real depreciated, and country risk rose.

The exchange rate increased from 2.29 to 2.37 reais per dollar, reaching 2.45 during the month. The Ibovespa index rose 3.7% in reais and 0.1% in dollars. Brazil risk measured by the 5-year CDS rose by 10.8%, to 206.9 bps.

What’s next?

The market will closely follow developments in the foreign exchange market, especially as changes in U.S. monetary policy edge closer. The focus will also be on the highway concession auctions scheduled for September. Additionally, it will be important to follow the next opinion surveys about the government.

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