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Brazil Likely to Cut Interest Rates Further
Oct. 14, 2011

Published by Minyanville

Inflation is up to its highest level in more than six years, with the rolling 12-month figure reaching 7.3% in September. However, the economy looks likely to be cooling with an expected further cut in interest rates next week as well as surprisingly low retail sales in August -- signs that Brazil’s surging middle classes may finally be calming.

It was food prices that have mainly fed the inflation rise, while airfares and ethanol prices have also increased, according to the Brazilian Institute for Geography and Statistics. The rolling 12-month figure of 7.3% is the highest since May 2005 and well above the government’s inflation target of between 2.5% and 6.5%.

Despite these worrying figures, the consensus is that inflation will fall. Central Bank chief Alexandre Tombini insisted to newspapers days after the figures were released that prices would go down this month. “Our horizon is December 2012 but in October 12-month inflation will begin to fall by 0.30 percentage points,” he told the Folha de São Paulo newspaper, still expecting the end-of-year figure to hit targets.

“One data point does not make a trend,” points out Joe Leahy in the Financial Times. However, the 0.4% contraction in retail sales in August, compared to July, has shocked many being the biggest slide since early 2010. The month also saw car and auto parts sales down 4.6%, a figure which looks likely to fall when September numbers are made public.

It is the middle class of Brazil who are widely blamed for its inflated economy, with their copious spending of credit on luxuries. Demand for consumer credit, however, is also slowing, down 10.7% in September in terms of the number of people searching for loans.

While one data point may not make a trend -- retail sales are up 6.2% year-on-year and credit demand is still higher than the same period in 2010 – most economists are forecasting growth of between 3% and 4% at the end of this year.

“All of this,” writes Leahy, “means that Brazil’s central bank is likely to continue cutting interest rates to make sure that the rock of the Brazilian economy, the consumer, keeps his or her spirits up.”

Tony Volpon and George Lei, strategists at Nomura in New York, believe a weakening real will push retail sales down further over the coming months. “Slower consumer demand should provide another reason for the central bank to continue its rate-cutting course,” they write in a note to investors.

That is the expectation for a Central Bank meeting to be held on Wednesday evening. Reuters’ polling expects the Bank to cut its benchmark rate by 50 basis points to 11.5%. This is likely to be repeated in November, predict the analysts spoken to.

Europe and China
One of the reasons for the weakening real is Europe’s ongoing sovereign debt crisis. Slovakia is the current weakest link in Europe, refusing to approve a revised European Financial Stability Facility. It is the only member of 17 nations to refuse to do so.

Brazilian Finance Minister Guido Mantego expressed his anger with Europe this week, saying that it was up to the EU countries to solve their own problems. “The biggest risk is here in the EU,” he told reporters, adding that another “Lehman Brothers situation” must be avoided.

Even China appears to be struggling slightly, as it posted a decline in its trade surplus. Relations between China and Brazil are incredibly strong, with Rousseff having visited the country in April. China imports many Brazilian commodities such as iron, soy and oil.

“Rousseff is spending more than five days in China this week not because she likes the food,” Gabriel Elizondo of Al Jazeera wrote at the time. “She is there because the China-Brazil trade relationship has become imperative.”

The trip was an important one as, despite the recent news on China’s trade surplus, Brazil’s relationship with the Asian giant is thought to have sheltered it from the worst of the global crisis.

“Brazil’s exports to China have increased by $28.8 billion since the turn of the millennium, while imports have increased by $24.3 billion during the same period, helping the Latin American country to obtain an advantageous $5.2 billion trade surplus in 2010,” writes Faizaan Sami in a Council on Hemispheric Affairs report published this week.

“Trade between the two countries has more than tripled in the past five years to $56.4 billion, solidifying China’s position as Brazil’s largest trading partner for some time to come; right now China’s share of Brazil’s exports is not far below that of the entire European Union.”

With such strong links to China, Brazil can perhaps get away with a slightly complacency in its position as the dominant emerging market.




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© Girish Gupta