- Economic activity has fallen sharply, but retail sales remain strong
- Inflation continues to fall, but the Selic rate was kept unchanged at 6.5%
- Given the fiscal situation and the more uncertain environment, we believe the end of the monetary loosening cycle is near
- External financial position remains the main shock absorber
- The Brazilian real is likely to remain weak heading into the elections
1. Economic activity
Economic activity figures for March were worse than expected. The monthly GDP indicator fell 0.7%, both yoy and mom. Retail sales still remain strong (up 6.5% yoy in March), helped by lower inflation and lower lending rates, but industrial production slowed from 5.8% yoy in January to 1.3% in March. The manufacturing PMI fell from 53.4 in March to 52.3 in April, but this still points to growth. All in all, recent figures remain consistent with our view of a moderate recovery and we hence maintain our growth forecast of 2.5% for 2018.
For more details on our Brazil outlook see our recent Brazil Watch – Debt, Politics and Custo Brasil
2. Inflation and monetary policy
Despite the fall in economic activity the central bank kept the target rate unchanged yesterday at 6.5%. The Bloomberg consensus view was for a cut of 25bp. A weaker currency – due to a less favourable external environment, combined with a poor fiscal and uncertain political situation – are probably the reason behind this decision. While inflation might pick up a little in the coming months, we expect it to stay in the lower bound of the target range (3-6%). Compared to other emerging markets, real interest rates are therefore still high. To reduce real rates further, a strong improvement of the fiscal situation is needed. This is not expected to happen before a new government takes over early next year. We therefore believe there is no room for rate cuts, even if external conditions improve.
3. External position remains solid
Brazil’s external financial position remains extremely healthy and will continue to act as an important shock absorber. The current account deficit fell from 1.3% in 2016 to 0.5% in 2017. FDI inflows have slowed but remain strong and still account for more than 3% of GDP. This has led to high levels of FX reserves as well, and stable foreign debt levels. We expect export growth to remain strong this year, and import growth to be more subdued than initially expected. As a consequence, we have lowered our forecast for the current account deficit from 1.5 to 0.5%. Next year, stronger investment growth will result in a pick up in import demand as well. This will lead to a rise in the deficit to a 1.5% in 2019.
4. Brazilian real to remain weak up to the elections
So far this year the Brazilian real has declined by 8% versus the US dollar. Global trade tensions, (geo) political risks, higher 10y US Treasury yields have resulted in general weakness of EM currencies including the real. Meanwhile, uncertainty about the upcoming elections in October has put extra pressure on the real and led to higher CDS spreads as well. It is likely that the real will remain under pressure in the run up to the elections in October. Moreover, geopolitical and trade uncertainty will remain. In addition, we expect 10y US Treasury yields to rise to 3.2% towards the end of 2018. This is in general a headwind for emerging market currencies. To reflect these dynamics, we have downgraded our real forecasts. Our new USD/BRL forecast for the end of 2018 and 2019 are 3.7 (previously 3.3) and 3.2 (previously 3.0) respectively.