BRL likely to depreciate further if BCB leaves door open for further rate cuts, says Commerzbank

The Brazilian real is expected to depreciate further if the Brazilian Central Bank (BCB) leaves the door open for further rate cuts, while if it decides to pause the rate cut cycle, the damage to the currency is likely to be limited, Commerzbank reported in its latest research report.

Following the December meeting most analysts (including us) had thought that the December rate cut from 5 percent to 4.5 percent would be the last one for a while. The economic recovery seemed to be gathering momentum and the central bank made it clear that the threshold would be high for further rate cuts due to the historically low key rate levels.

However, as the recently weak data publication led to doubts about the economic recovery the majority of analysts now expects the central bank to cut interest rates by another 25bp again. As inflation has risen to 4.3 percent in December it is hardly surprising that the low key rates are increasingly turning into a negative factor for the BRL.

That is likely to make today’s decision more difficult for the central bank; if it loses its credibility there is a risk of much stronger BRL depreciation which would force the central bank to drastic rate hikes. Therefore, there stands a small chance that the central bank will not cut its key rate today, the report added.

After all this gives rise to the question as to whether a 25bp rate cut really can be that effective that it is worth risking the central bank’s credibility for it. On the other hand the opportunity for a rate cut is quite good as the majority on the market is expecting the step anyway.

"We therefore admit that the likelihood of a rate cut is high. What will probably matter most for BRL will be the accompanying statement," Commerzbank further commented in the report.