April 8 2011
Brazil’s currency has surged over the past two weeks, breaking one of the market’s most important resistance levels, as speculators have seized on an apparent shift in government policy.
The country has long been at the forefront of the so-called currency war, introducing a barrage of aggressive measures specifically designed to curb the appreciation of the overvalued real.
However, the government appears to have called a temporary truce, concentrating instead on Brazil’s ever more worrying inflation problem.
“We’ve sensed a shift in policy away from the exchange rate towards inflation and ultimately the real was the beneficiary of this,” said Flavia Cattan-Naslausky, a strategist at RBS Securities.
Late last year, the government concentrated on measures that would curb dollar inflows, such as tripling the tax it charges foreigners when they buy local bonds. However, since President Dilma Rousseff took office this year, the government has tried to tackle the economy’s problems in a more comprehensive way via so-called “macro-prudential measures”.
In the third such announcement in two weeks, the government said on Thursday that it would double the tax on consumer credit. The measure will help tame inflation, which has come dangerously close to the upper limit of the central bank’s target, but also help the country to bring down its benchmark interest rate, one of the highest in the world and the fundamental reason behind the currency’s strength.
Although the move has been welcomed by economists, traders have jumped on this policy shift as a green light to start pushing the real to even stronger levels.
“We’re seeing a big speculative attack on the real,” said Andre Ferreira, director of the Futura brokerage in São Paulo.
“Four or five of the big foreign banks have been amassing a huge position, crushing the market and seeing how far they can test the government’s patience,” he said.
The real hit a fresh two-year high on Friday, firming to around 1.57 to the dollar and consolidating its break of the key 1.60 level. That is over 5 per cent stronger than it was at the beginning of last week and almost 50 per cent stronger than it was at the beginning of 2009.
Traders said they saw the real strengthening further to settle in the 1.50-1.55 per dollar range.
“We still have real economy flows and a lot of IPOs (initial public offerings) lined up,” said RBS’s Flavia Cattan-Naslausky. “If the government will not put a line in the sand then the market will keep its position.”
About $35bn has already flowed into Brazil during the first three months of this year, more than came in during the whole of 2009 or 2010, according to central bank data.
However, analysts warned about dismissing the possibility of further aggressive measures if the currency breaks the 1.50 per dollar level.
Alfredo Barbutti, an economist at the BGC Liquidez brokerage in São Paulo, said the government is not relying on a stronger currency to solve its inflation problems. Instead, its short-term appreciation is simply an effect of the government’s decision to tackle the long-term causes of the problem.
“There are many components of the inflation index which wouldn’t be affected by having a stronger currency anyway,” he said.
As such, the market should be prepared for other measures such as quarantines on capital inflows, said Carlos Gandolfo, a partner at São Paulo’s Pioneer brokerage.
“The government has been trying to cure the problem one dose at a time but it still may have to resort to something bigger,” he said.