Brazil walking monetary policy tightrope, says top strategist

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The on-going investor guessing game over how low Brazilian interest rates can go could lead to the country losing touch with global markets, according to AllianceBernstein’s leading economist on Latin America.

In a market update focusing on Brazilian monetary policy, Lars Pedersen said many commentators and investors have raised the question of how far the country’s central bank will go in cutting rates.

This comes after the Brazilian central bank enacted its latest in a series of interest rate cuts - taking the Selic rate down to 10.5%. It had stood at 12.5% in August before a series of cuts were undertaken beginning in August 2011.

‘Based on sentiment in the futures market, the low cycle for this cycle is expected to be about 10%, with interest-rate hikes resuming once again in 2013. In our view, policy rates could actually end up much lower than that – given the right conditions,’ he said.

Market commentators and fund managers had questioned whether the interest rate cuts were the right tact. And, it was suggested the move was modeled around a much worse global slowdown than has occurred.

Inflation in the country is expected to fall as planned, Pedersen said, but the policy in this area is still not completely clear.

‘Brazil saw a very large hike in its minimum wage as 2012 started; this will almost certainly increase the costs of local services as it restarts the economy’s halting recovery,’ Pedersen said.

Public policy

Pedersen said efforts to keep the country on the same footing of global rates have led to draconian capital controls for its overvalued currency, as well as creating a gap between rates for public projects and the Brazilian people.

For the country to get onto a more solid foundation, Pedersen said the Brazilian government has to stop directly entering the credit market and redirecting funds to specific areas of the economy through development banks.

‘Brazil can bring its financial markets towards normal if the public sector and political-interest groups can bear to give up their pet projects and sources of cheap, subsidized financing,’ he said. ‘If they’re unwilling to do so, normalcy may be beyond reach.’