The energy rationing implemented in May is prompting a slowdown in industry, the engine behind last year’s strong rebound.  Meanwhile, the Central Bank has tightened again to forestall further currency depreciation resulting from the Argentina spill-over, which is likely to undercut the pace of investment and consumption growth this year.

Currency deterioration quickens and prompts further monetary tightening.  The Real continued to depreciate strongly in the first three weeks of June losing an additional 4.6%, which came on top of the 7.4% nominal depreciation in May.  In an effort to bolster the currency, the Central Bank raised interest rates for the fourth time this year from 16.75% to 18.25% on 20 June.  The unexpected 150 basis point hike was well received by the market but could not stop the slide of the Real.  To further strengthen its position to defend the Real and to boost international reserves, the Central Bank also announced its intention to tap into a US$ 2.0 billion stand-by loan with the International Monetary Fund (IMF) and delay repayment of an existing US$ 1.8 billion outstanding IMF loan.  The Central Bank’s actions bore fruit, lifting the Real by 2.4% by the end of June from its historical low of 2.47 Real to the US$ on 20 June.  Nevertheless, the currency closed down even further at 2.49 Real to the US$ on 6 July and has now lost 21.6% of its value against the US$ since the beginning of the year.  The persistent currency depreciation has prompted another revision in the Consensus for this year.  The Central Bank’s baseline scenario assumes that the benchmark Selic interest rate will remain at 18.25%, well above the 15.75% figure reported in March.  The June interest rate hike and a weaker currency outlook have prompted participants to raise their interest rate forecast.

Central Bank ups inflation target again and undermines credibility.  Central Bank concerns about the possible pass-through of the recent currency depreciation to domestic price levels and the likelihood for higher prices resulting from current energy rationing prompted the Central Bank to raise its inflation target from 4.8% to 5.8%, the second increase this year following a 0.9 percentage point adjustment on 30 March.  The mid-June consumer price index (IBGE-IPCA 15) that registers price increases in the first 15 days of the month over the same period in the previous month, increased 0.38% over 15 May.  Primarily, rising transport and housing costs drove the price increases.  The Central Bank claims that the currency deterioration and rising energy costs required a second revision.  However, raising the inflationary target rather than continuing to adopt the necessary monetary policy adjustments needed to comply with stated inflation goals undermines credibility gained via recent interest rate hikes.  Participants have factored the Central Bank revision into this year’s inflation forecast, which was raised modestly. 

Energy rationing and rising inflationary expectations affect growth outlook.  On 5 July, the Central Bank cut its growth outlook for this year from 4.3% to 2.8%, which is well below the government’s estimate of 4%.   Monetary authorities undertook the revision as a result of mounting concerns over the likely downside effect of the government’s energy rationing programme on domestic economic activity.  In addition, The Central Bank sees its recent interest rate hike as hampering domestic demand. 

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