Tumbling Real Shows Limit to Brazil’s Monetary Easing Cycle

(Bloomberg) -- As the Brazilian real tumbles on prospects of more interest rate cuts, investors are wondering how much weaker the currency can get before it starts curtailing the monetary easing cycle.

Policy makers this week cut the benchmark Selic rate to a record low and signaled further reductions are on the way, igniting market speculation that the aggressive easing may end up sealing its own fate. The real is already one of the worst-performing emerging market currencies, and further weakness could eventually fuel inflation.

“Borrowing costs are poised to fall below 5% if the currency permits,” said hedge fund veteran and Truxt Investimentos Chief Executive Officer Jose Tovar, who added that the real weakening beyond 4.30 per U.S. dollar could be an obstacle. “It would depend on the pace of the depreciation and the behavior of other emerging-market currencies.”

The real weakened 1.4% on Thursday to 4.17 per U.S. dollar. It has lost 8.5% since July 31, more than all 24 emerging market currencies tracked by Bloomberg except the Argentine peso, which has been battered by prospects of a return to a leftwing government there.

Read more: Brazil Lays Out Plans for More Rate Cuts on Inflation Optimism

In August, when the real approached 4.20 per dollar, the central bank tempered bets of further depreciation by carrying out surprise currency interventions during trading hours. The monetary authority, which is headed by former Banco Santander SA Treasurer Roberto Campos Neto, also started selling dollars from international reserves for the first time in a decade.

Benign Scenario

To be sure, economists and policy makers still see annual inflation below next year’s target even after the real’s recent slide. Consumer prices rose 3.43% in the 12 months through August, and a central bank survey released on Monday showed analysts see inflation ending 2020 at 3.8%, below the 4% target for that year.

In the statement published after the key rate decision on Wednesday, policy makers said that “the consolidation of the benign scenario for prospective inflation” should allow for more easing. Price increases will remain below target even if rates fall further and the real stabilizes at 4.05 per dollar, they wrote.

“The Brazilian real would bring discomfort only if it weakens beyond 4.40 per dollar, as inflation seems to remain on target even with a currency between 4.20 and 4.30,” said Carlos Menezes, a Sao Paulo-based portfolio manager at Gauss Capital. “If trade concerns ease and economic growth indicators start to pick up, then the market should start buying the real.”

The central bank declined to comment on the real’s impact on monetary policy when contacted by Bloomberg.

Going forward, there’s no sign that the debate will let up. On one hand, lower borrowing costs may make the currency even less appealing to investors by reducing its potential for carry trade.

Still, the central bank will remain under pressure to continue reducing the key rate to boost economic growth that’s seen around just 1% for the third straight year.

Given the dire state of Brazil’s fiscal accounts, Campos Neto will have to bear the burden of injecting stimulus, according to Andre Perfeito, chief economist at Sao Paulo-based brokerage Necton.

“Campos Neto was put between a rock and a hard place now, as the rate cut will eventually weaken the real further,” Perfeito said. “It seems like he is alone with the task of providing stimulus to the economy, as not much can come from the fiscal side.”

To contact the reporters on this story: Mario Sergio Lima in Brasilia Newsroom at mlima11@bloomberg.net;Vinícius Andrade in São Paulo at vandrade3@bloomberg.net

To contact the editors responsible for this story: Walter Brandimarte at wbrandimarte@bloomberg.net, Matthew Malinowski

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