Latin America’s top economy signals bigger cut: Brazil credit

Traders are betting central bank President Alexandre Tombini will step up the pace of interest- rate cuts as growth in Latin America’s biggest economy slows and Europe’s debt crisis spreads.

Policy makers may lower the benchmark Selic rate by as much as 75 basis points to 10.75 percent after reducing it by 50 basis points in each of their past two meetings, futures trading shows. Yields on rate futures contracts maturing in January 2013, the most traded in Sao Paulo, plunged 39 basis points in the past nine trading days to a near four-year low of 10 percent yesterday.

Banco Central do Brasil’s rate cuts are part of an effort by policy makers around the world to shield their economies from the global slowdown. Indonesia yesterday unexpectedly lowered borrowing costs, following reductions by central bankers in Israel and the European Union. Brazilian President Dilma Rousseff’s administration is concerned the economy may slip into recession and is debating measures to shore up growth, a government official said on Nov. 9.

“The slowdown of the Brazilian economy has been stronger than expected and this gives margin for some to think the central bank can be more aggressive,” Marcelo Salomon, chief economist for Brazil at Barclays Plc, said in a telephone interview from New York.

Yields on Brazil’s benchmark bonds due in 2021 have dropped 36 basis points to 11.30 percent since Tombini unexpectedly lowered rates on Aug. 31, according to data compiled by Bloomberg. He had previously raised borrowing costs five times in seven months to bring the annual inflation rate down from a six-year high of 7.3 percent in September. Raising rates stems inflation by reducing demand for loans and spending. A basis point equals 0.01 percentage point.

Slowing Inflation

Annual inflation slowed for the first time in 14 months to 7 percent in October, the national statistics agency said yesterday in an e-mail.

The yield gap between five-year inflation-linked bonds and interest-rate futures, a gauge of investors’ expectations for annual consumer price increases by 2013, fell to 5.74 percentage points from a three-year high of 6.5 percentage points on Sept. 21, according to data compiled by Bloomberg.

The central bank said on Oct. 19 that “moderate” rate cuts would mitigate the impact of slower global growth without jeopardizing its goal of bringing inflation back to Brazil’s 4.5 percent target next year.

The central bank declined to comment in an e-mailed statement yesterday.

‘Reacted Correctly’

Industrial production contracted 2 percent in September, more than all 38 economists surveyed by Bloomberg had expected. It was the second biggest fall since the decline that followed the collapse of Lehman Brothers Holdings Inc. in 2008. Average real wages fell 1.8 percent in September from the previous month to 1,607.60 reais ($913) a month.

“The view that the central bank may have reacted correctly by cutting rates gains strength with the worsening of the crisis” in Europe, Salomon said. He forecasts policy makers will reduce the benchmark interest rate by 50 basis points this month to 11 percent.

Italy’s bond yields soared to a record earlier this week and Prime Minister Silvio Berlusconi offered his resignation, fueling concern Europe’s deepening debt crisis will exacerbate the global slowdown.

Ronaldo Patah, who manages 72 billion reais as head of fixed-income debt at Sao Paulo-based Itau Asset Management, predicts the central bank will fail to meet the inflation target. Patah, who expects inflation to end 2012 at 5.7 percent, said he’s buying inflation-linked bonds and betting the breakeven rate will reverse its two-month decline.

‘Very Important’

“Here in Brazil, gross domestic product growth is very important for the government,” Patah said in a telephone interview. “Because of this kind of objective, that puts a floor under inflation. It’s hard to see inflation below 5 percent.”

Traders expect the central bank will have to increase benchmark borrowing costs by 25 basis points in the second half of next year after cutting them to as low as 9.75 percent by July, rate futures show.

Rate futures indicate the central bank may lower rates by 60 basis points, showing traders are split between a cut of 50 and 75. They signaled a reduction of 67 basis points on Nov. 9.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell 1 basis point to 220 at 10:57 a.m. in Sao Paulo, according to JPMorgan Chase & Co.

Default Swaps

The real rose 0.3 percent to 1.7564 per dollar.

The cost of protecting Brazilian bonds against default for five years fell 4 basis points yesterday to 159, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Brazil is considering removing credit restrictions imposed in the last 11 months as Rousseff seeks to shore up growth, said the government official, who asked not to be identified because the matter is still under discussion.

GDP will contract 0.3 percent in the third quarter and expand 0.2 percent in the fourth quarter, said Marcelo Carvalho, head of Latin America economic research at BNP Paribas SA.

‘Gets Louder’

“Given the recent data, I wouldn’t be surprised that the debate over whether Brazil is or isn’t in technical recession gets louder,” Carvalho said in a telephone interview in Sao Paulo.

The government is “bold enough” to use the tools at its disposal to protect the economy from the global slowdown, Finance Minister Guido Mantega told Globo News on Nov. 9.

The Finance Ministry declined to comment in an e-mailed statement.

Economic growth will slow to 3.5 percent this year from 7.5 percent in 2010, according to central bank estimates.

The European Commission cut its euro-region growth forecast for next year by more than half and said it sees the risk of a recession as leaders struggle to contain the fiscal crisis. GDP may grow 1.5 percent this year and 0.5 percent in 2012, the Brussels-based commission said yesterday. It had earlier projected the 17-nation region to expand 1.6 percent and 1.8 percent this year and next, respectively.

“Given the external outlook, there is room for interest rates to fall further,” Marina Santos, chief economist at Squanto Investimentos Ltda, said in a telephone interview from Sao Paulo. “If the outlook worsens, the central bank will quicken the pace of cuts.”