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The Globe and Mail

Brazil likely to let real slip, but not much

Brazil’s President Dilma Rousseff watches a ceremony in Brasilia, Nov. 21, 2012.


Brazilian President Dilma Rousseff is likely to loosen the informal trading band for the country's currency and let the real gradually weaken beyond 2.10 per (U.S.) dollar, but such an adjustment will be minor because of concerns over inflation.

The real was about 0.7 per cent weaker in late trading on Wednesday at 2.095 per dollar, following rising aversion to riskier assets in global markets.

Traders were eager to see whether Brazil's central bank would intervene in the market, as it has done in recent months when the real threatened to break out of its de facto trading band of 2 to 2.10 per dollar.

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Ms. Rousseff's recent statements on the real, plus comments from other senior officials, suggest the government will tolerate a slightly weaker currency in coming weeks if the market continues to push it in that direction.

A weaker real could help Brazil's manufacturers, which have struggled with an overvalued currency and high input costs. The real is 12 per cent weaker this year, but is still 19 per cent stronger than it was in 2008.

However, the central bank might still intervene to prevent an excessively quick depreciation that could destabilize the broader economy. It will likely tolerate only a small shift in the trading band, to 2.12 or 2.15 at most in the near term, because of concerns a weaker real could complicate the bank's inflation target in 2013 as economic activity picks up.

Finance Minister Guido Mantega told reporters on Wednesday that the real was "fluctuating normally" and that the government was intervening as little as possible in foreign exchange markets – comments that indicated a lack of concern as the real crept closer to 2.10.

In some of her most explicit comments about foreign exchange rates in recent months, Ms. Rousseff told Valor Economico newspaper this week that "we're looking for an exchange rate that is not this one, with a devalued dollar and an overvalued real."

Those comments helped push the real lower on Wednesday. The session was also unusually volatile because many traders were on holiday on Monday and Tuesday, and because of the coming Thanksgiving holiday in the United States.

Influential Valor columnist Cristiano Romero wrote on Wednesday that the government may be seeking a significantly weaker real in the medium term, at 2.20 to 2.25 per dollar.

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However, some in the market thought that view was a misinterpretation of Ms. Rousseff's comments.

"We do not agree with this reading and believe that the ceiling is closer to 2.10 than it is to 2.15," Barclays said in a note to clients on Wednesday.

"With economic activity gaining momentum, another round of (real) depreciation could have a larger effect on inflation, which is an event we do not believe the (central bank) is looking for," Barclays said.

Financial markets expect that consumer inflation could hit 5.39 per cent next year – above the mid-point of the government's inflation target of 4.5 per cent, with a tolerance band of 2 percentage points in each direction.

Some analysts expressed concern that the apparent policy shift could signal a softer government stance on inflation – something officials rigorously deny.

"It seems to me that there is a co-ordinated policy effort … which signals that they can live with a weaker real," said Flavia Cattan-Naslausky, an analyst with RBS Securities.

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"But I don't see them having that much conviction on the inflation side. They seen to be ready to (let the real weaken) and that raises the question if they are also letting inflation go. This is negative for Brazil."

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