Brazil's Real surges following central bank's aggressive rate hike

Brazil's markets made a brisk gain on Thursday as the central bank decisively voted to raise interest rates - and a statement that many would call hawkish signalled a commitment to getting inflation back on track, according to a report by Bloomberg.

The real trimmed gains after surging as high as 1.2 per cent against the dollar, and swap rates rose after central bank officials raised the benchmark rate by 25 basis points late Wednesday, just hours after the US Federal Reserve delivered its first cut in four years. Though widely expected from economists and investors, the tone of the accompanying statement pushed traders to price a faster pace in the next meetings.

Brazilian real is performing according to higher carry, with the rather hawkish message from the BCB, benefiting from the lower rates in the US,” said Marco Oviedo, senior Latin America strategist at XP Investimentos.

Meanwhile, Brazil's benchmark index had given up some of its earlier session gains, as global appetite for risk continued to rise after the Fed's easing. Raphael Figueredo, CEO and analyst at Eleven Financial, said investors are “recalibrating their positions because they understand that there is more room for Selic rate to rise due to the tougher tone in the statement.” Short-end swap rates soared by over 20 basis points.

Board members noted in the statement that the risks are skewed to the upside of their inflation outlook, and the scenario requires a more restrictive monetary policy. In focusing on the strength of the Brazilian economy and unanchored inflation expectations, analysts said markets should price in 50 basis point raises at next meetings.

Higher rates at home should lift the currency, as a bigger rate gap with the US makes it more appealing to carry traders.

Annual inflation eased from the top of the tolerance range to 4.24 per cent in August, said the National Statistics Institute — a retreat that did little to ease the squeeze on central bankers to raise rates.

The hawkish rate hike by Brazil puts Latin America's biggest economy at odds with virtually every other central bank in the region, which are lowering rates to shore up fragile economies. Chile, Peru, Mexico, and Colombia have all cut their borrowing costs in recent weeks.

“The BCB is likely to be the hawkish central bank over the next three months in the region, while valuations are attractive and positioning light, whereas the MXN remains vulnerable to domestic policy risks, especially if risks of constitutional reforms resurface over the coming weeks, but also to US election risks,” Alexandre de Azara, economist at UBS BB Investment Bank, wrote in a note.