Data and Policy Mix Frustrate Attempts to Stabilize BRL

Brazil has reported FIPE inflation and Oct industrial production figures today. The former did not rise as much as expected and the latter was a stronger than expected. FIPE calculation of CPI rose 0.29% in Nov. The consensus was for a rise of 0.32%-0.34%. In Oct, it rose 0.25%. The important point here is that Brazilian inflation appears to be back near the official target.

Industrial output rose 2.2% compared with consensus guesstimates of closer to 2% and the Sept series was revised to a 1.8% rise from the initially reported 0.8% gain. The important point here is that the economy is expanding at a reasonable clip and is capacity utilization rates appear to be rising.

Add on top of this the extension of fiscal stimulus in the form of tax benefits for the purchase of autos, building materials and furniture. This is not only provides more support to already bustling economy, but it also underscores the deterioration of the budget position. The primary surplus (= budget balance minus debt servicing costs) is near 1%, among the lowest under President Lula.

What does all this mean ? It suggests the central bank may respond. The statement at the Dec 9 policy making meeting may signal that Brazil will join a small number of other countries (Israel, Norway and Australia) in raising rates. The first hike could come early next year.

That policy mix of tighter monetary policy and loose fiscal policy tends to be associated with appreciating currencies. So far the BRL1.70 area has provided a floor for the US dollar. Even with a 2% transaction tax, officials have not broken the back of the BRL bulls. The yield pick up on BRL bonds remains substantial for numerous investors and the Bovespa was up 2% alone yesterday to new 2009 highs and is less than 8% below its all time peak from last May.