The Brazilian real moved back above the 4.00 threshold and stabilised within the 4.00 and 4.07 over the last couple of weeks. Data last week showed that Brazil's inflation rate closed 2015 at the highest level in more than 12 years, above 10 percent, overshooting the government's target and prompting the central bank to vow action to curb prices despite a deepening recession.
The BCB Copom meets next week on Jan. 20th and will need to contemplate the merits/demerits of resuming the tightening cycle. There are three options that the BCB has: 1) an immediate and significant rate hike followed by easing later this year, 2) resumption of gradual tightening following trends in inflationary expectations and growth concerns and 3) keeping the rate high at current levels for a long period of time.
Brazil's inflation is in contrast with deflation fears elsewhere in the world, caused by slowing Chinese growth and falling oil and commodities prices. However, most of Brazil's price pressures are domestic, underpinned by loose fiscal policy.Expectations are for Brazil's inflation rate to peak in a few months and close the year at just below 7 percent, still above the government's target, according to a central bank poll.
Given the expected decline in inflation this year, real interest rates should rise sharply, negating the need for additional nominal tightening. That, combined with recession fears, may prevent the BCB from raising rates further in this cycle, although the upside risk will increase in case of additional pressure on the BRL.
