Itaú BBA - Gradual Recovery and Still-High Inflation

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Gradual Recovery and Still-High Inflation

November 1, 2013

Positive Surprises, but Fundamentals Suggest a Gradual Economic Recovery

The Brazilian economy in October 2013

Some indicators on economic growth surprised on the upside, but the fundamentals continue to indicate a gradual recovery. Food prices eased inflation somewhat, but core measures remain under pressure. The Central Bank raised the benchmark interest rate, to 9.50%, and signaled maintenance of the hiking pace. Marina Silva entered the presidential race in an alliance with another pre-candidate, Eduardo Campos. The auction for the Libra pre-salt oil field was concluded, with the participating consortium including two European companies and two Chinese companies.

Positive Surprises, but Fundamentals Suggest a Gradual Economic Recovery

Core retail sales (ex-vehicles and building materials) advanced in August (0.9%), extending the sharp increase in July and marking a second consecutive month of better-than-expected readings. New government-registered jobs expanded from 58 thousand in August to 91 thousand in September (seasonally adjusted), marking the largest growth in 14 months. However, many fundamentals continue to indicate a just-moderate economic growth pace, including the high industrial inventories, rising interest rates, declining business confidence, decreasing room for fiscal and parafiscal stimuli and delays in the infrastructure concession program.

Inflation Slows, but Core Measures Remain High

The IPCA consumer price index rose 0.35% in September (vs. 0.24% in August), in line with expectations. Year-over-year inflation slid to 5.9% (vs. 6.1% in August), while the year-over-year change in the food group continued to decelerate, to 9.2% from 10.5% in August and 14.0% in April. However, the core measures in the IPCA remain above the headline index, suggesting no downward trend in underlying inflation.

The COPOM Maintains its Pace

The Central Bank`s Monetary Policy Committee (COPOM) raised the benchmark SELIC rate by 50 bps, to 9.50% p.a., in a unanimous decision, as widely expected. The minutes of the meeting suggest that the hiking cycle should be extended for a while longer in order to help reverse the inflationary resilience that is “still” being observed. The word “still”, which was added to the latest minutes, may indicate that the already-implemented monetary tightening and recent evolution of inflation drivers (particularly exchange-rate dynamics) make the prospective scenario more favorable. Overall, the minutes maintained the tone of previous communications, signaling continuity in the pace of interest-rate increases. We now expect an additional 50-bp hike in November and a final 25-bp increase in January, pushing the SELIC to 10.25% next year.

Marina Joins Eduardo Campos

After an electoral court denied the registration of her party Rede Sustentabilidade (Sustainability Network) due to insufficient signatures, Marina Silva joined the Brazilian Socialist Party (PSB), home to another presidential pre-candidate, Eduardo Campos. The alliance between the two politicians came as a surprise. They are working on designing a joint government program and have not yet announced who will head the party’s ticket in 2014.

The Government Wraps Up the Libra Oil Field Auction

The government wrapped up the auction of Libra, the first pre-salt oil field to be auctioned under the sharing system. Only one consortium participated, winning with the minimum bid established by the National Petroleum Agency (ANP); 41.65% of the profits will go to the government. The consortium is comprised of Petrobras (with a 40% share, or 10 pp more than the minimum share set by auction rules), two state-owned companies from China (CNOOC and CNPC, with 10% each), and Shell and Total (with 20% each). The consortium will pay the government 15 billion reais as a signing bonus this year.

President Rousseff Leads the Voting Polls

According to the latest Ibope survey, President Dilma Rousseff (PT) is heading the electoral race. With 41% of the voting intentions, the President would be reelected in the first round, beating likely adversaries Aécio Neves (PSDB), at 14%, and Eduardo Campos (PSB), at 10%. In a simulation with Marina Silva (PSB) heading the party ticket instead of Campos, the party’s share widens to 21%, with Rousseff’s falling to 39% and Neves’s to 13%. Compared with the Datafolha survey released last week, the Ibope poll indicates that opposition candidates are less popular and that there is a larger share of blank votes and undecided voters.

Brazilian Assets Appreciate

The Brazilian real strengthened 1.2%, closing at 2.20 per U.S. dollar, and the 5-year Brazilian CDS declined 4.9% to 168. The stock market also improved, climbing 3.7% in local currency (5.0% in U.S. dollars).

What’s next?

The market is now focused on the next COPOM meeting, scheduled for November 27, as well as the possible change in the Central Bank’s strategy regarding the currency market, given the recent appreciation of the local currency. News of the electoral proposals by the Marina-Campos pairing will also garner some attention.

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