By Marcela Ayres and Fernando Cardoso
BRASILIA (Reuters) – Brazil’s currency reversed course on Thursday, weakening against the U.S. dollar despite a bigger-than-expected rate hike by the central bank and its signal of more aggressive increases ahead.
After opening the session 1% higher, the Brazilian real reversed course and ended the day 0.9% lower at 6.01 per dollar. Meanwhile, the long end of the yield curve widened, reversing an initial downward move.
“The budget issue remains a concern,” said Daniel Leal, senior fixed income strategist at BGC Partners (NASDAQ:). “The market is very fragile, with small positions causing significant curve movements.”
The currency had already erased initial gains, but the depreciation trend intensified following comments from presidential spokesman Paulo Pimenta, who stated that President Luiz Inacio Lula da Silva will seek re-election in 2026.
The 79-year-old leftist leader is in hospital recovering from two operations to relieve bleeding in his skull, with his health fueling speculation about his viability as a candidate in the next presidential election.
Eduardo Moutinho, market analyst at Ebury Bank, noted that Lula’s reappointment as candidate “renewed pessimism about possible government intervention through populist measures, further undermining fiscal responsibility.”
Budget problems were at the heart of the central bank’s decision on Wednesday, when it raised interest rates by more than 100 basis points to 12.25%.
Policymakers said negative market perception of government fiscal measures had a significant impact on asset prices, contributing to more negative inflation dynamics.
A recent rise in the country’s risk premium, which has weakened Brazil’s real and sent interest rate futures higher, has gained momentum after the government unveiled a long-awaited austerity package that disappointed expectations and undermined confidence in its ability to manage growing public debt. further undermined control.
FORWARD GUIDANCE
Policymakers also pointed to increases of the same magnitude at the next two meetings, indicating that a shift to a new governor will not weaken the central bank’s resolve to fight inflation.
Wednesday’s interest rate decision was the last under the leadership of central bank chief Roberto Campos Neto, who will be replaced in January by current monetary policy director Gabriel Galipolo, a close ally of Lula who was part of the discussions on the budget package before the announcement.
Next (LON:) This year, Lula will have a 7-2 majority on the central bank’s nine-member rate-setting committee, known as Copom, up from the current 4-5 minority.
Presidential spokesperson Pimenta criticized the central bank’s latest decision, saying its current approach was heavily influenced by “speculative market logic and interests.”
“I hope that this reality will change next year, creating market dynamics that better suit the country’s interests,” he said.
Economists at UBS BB led by Alexandre de Azara said the strongly negative reaction to the package likely prompted the central bank to reconsider its position on issuing forward-looking guidance, which it had tried to avoid.
“Since January 2024, there has been no forward guidance at multiple meetings. Now they can try to stabilize inflation expectations and market pessimism,” the UBS BB economists wrote.
They added that they expect less volatility going forward, with the central bank’s Selic rate peaking at 14.25% in March, compared to a previous forecast of 13.50%.
However, economists at BTG Pactual said they now expect the central bank to implement a final rate hike of 50 basis points in May, taking the Selic to 14.75% – the highest level since 2006.
“If economic policy adjustments do not match this more intense rate hike trajectory, inflation convergence towards the target will remain at risk, with a broader deterioration in economic expectations for 2025-2026,” they said.
