Brazil’s economy possibly at turning point; BCB likely to lower key rate by end-August

There are tentative signs that Brazil’s economy might have reached a turning point. The economy, in the first quarter contracted 0.3 percent quarter-on-quarter as compared with projections of 0.8 percent contraction and Q4’s 1.3 percent contraction. Moreover, consumer sentiment is rising in spite of growing unemployment. Also, retail sales grew for the first time in over a year on a sequential basis. Industrial production grew a bit in April and March. But firms in service and industrial sectors continued to be quite pessimistic as the PMI composite dropped to a new record low last month.

The Brazilian government is proceeding with its intentions to consolidate public finances and is planning to set up a spending cap in the next 10 years and also cut pension outlays. Enhancing public finances is important for improving investor sentiment. Assuming that the new government continues to stay in power, the Brazilian economy is then projected to shrink 3.6 percent in 2016 and grow 1.2 percent in 2017, said Danske Bank in a research report.

Meanwhile, the Central Bank of Brazil has maintained its key interest rate at 14.25 percent in June. Inflation pressures, as expected, have begun alleviating with the stability in Brazilian real and rising slack in the economy. The BRL is expected to be relatively stable in 2017. Given this projection, inflation in the country is expected to decelerate further in the months to come. Therefore, there is a possibility that the Selic rate will be reduced in by the end of August, according to Danske Bank.

The BRL has continued to remain stable against the USD since the new government came into effect on 13 May. The Brazilian real is likely to bolster slightly over the forecast horizon of 1 to 12 months because of FX demand related to the Olympics in August and the continuing improvement in external balances, noted Danske Bank. This is expected to slightly outweigh upward pressure on the Brazilian real from the decelerating inflation.

“Our USD/BRL forecast is 3.40 in 1M, 3.35 in 3M, 3.30 in 6M and 3.20 in 12M”, added Danske Bank.