Itaú BBA - Brazil: more depreciated exchange rate and higher inflation

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Brazil: more depreciated exchange rate and higher inflation

August 21, 2013

The exchange rate reached the level of 2.40 reais per dollar after fluctuating for a few days around 2.30.

Last week, the real depreciated rapidly against the dollar. The exchange rate reached the level of 2.40 reais per dollar after fluctuating for a few days around 2.30. Part of the movement is explained by external factors. Long-term interest rates in the United States are up again. However, domestic factors have also contributed to a more persistent depreciation of the currency. Thus, we believe that the exchange rate will likely remain at a more depreciated level than what we expected in our scenario review earlier this month. We raised our exchange rate forecast at the end of 2013 to 2.45 reais per dollar (previously 2.30) and to 2.55 reais per dollar at the end of 2014 (previously 2.40). Faced with a more depreciated exchange rate, we raised our forecast for the IPCA in 2013 from 5.9% to 6.1%, and from 5.8% to 6.0% in 2014.

Our assessment is that both external and internal factors lie behind the recent depreciation of the real against the dollar. On the external side, the prospect of tapering of asset purchases by the U.S. central bank (Fed), probably starting in September, will likely raise interest rates in the U.S. and change the direction of capital flows. Monetary policy should become less expansionary than what was previously expected. In Europe, there are more positive signs of growth, which also leads to the shift of investors from emerging markets towards advanced economies, affecting flows to Brazil.

On the domestic side, the scenario of lower growth and higher inflation affects investors' mood. Investors are also concerned about the decline in the primary surplus. In addition to the exchange rate depreciation, the consequence of the drop in confidence is an increase in market interest rates and in the country risk premium (measured by the 5-year CDS), which again exceeded 200 bps in the last few days. The perception that Brazil needs to regain competitiveness for its products should maintain the pressure on the currency in the medium term.

Therefore, we believe that the real will remain more depreciated over the coming quarters. The central bank will likely prevent steeper depreciation through new interventions in the foreign exchange market (the central bank already sold about 39 billion dollars in swaps up to this moment). We forecast that the real will remain at a more depreciated level (compared to our previous forecasts), ending this year at 2.45 reais per dollar and ending 2014 at 2.55 reais per dollar. With the prospect of a more depreciated exchange rate, inflation will likely end the year at a higher level. We forecast 6.1% for the IPCA in 2013 and 6.0% in 2014.

Forecast: Brazil*

Source: IMF, IBGE, BCB, Haver and Itaú

* We have only changed the forecasts for the exchange rate and inflation (IPCA) compared with the table published on “Scenario Review – Brazil” from August 9, 2013. The remaining variables will be adjusted in the next Scenario Review.



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