Brazil's financial markets already start to anticipate early end to interest rate increases thanks to euro crisis

05/20/2010 10:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

In theory—well, in my theory, anyway—the euro debt crisis and the resulting slowdown in Europe’s economies will gradually reduce inflationary pressures in developing economies. And that will lead central banks in countries such as Brazil, India, and China to raise interest rates less than is now projected.

As a result emerging stock markets, which are taking a beating from a flight to safety during the euro crisis, will bottom sooner rather than later and bounce back faster.

The timing depends on when central banks in developing economies decide it’s safe to stop raising interest rates.

It looks like financial markets in Brazil are starting to price in that possibility, Yields on Brazil’s interest-rate futures contracts due in January have declined by 0.24 percentage points from a 15-month high set on May 3. Maybe, the thinking goes, the Banco Central do Brasil will need to raise interest rates by less than expected because of falling commodity prices. Commodities make up 41% of Brazil’s exports. The UBS Bloomberg CMCI raw materials index is down 12% from mid-April. Europe is Brazil’s largest export market.

The change in expectations isn’t large so far. According to Bloomberg, traders are now expected that benchmark interest rates will hit 12% by year end. That’s down from projections at the end of April of 12.75%.

The benchmark rate now stands at 9.5% after the Banco Central raised the rate by 0.75 percentage points in April. So even a move to a lower 12% benchmark rate by the end of 2010 implies several more rate increases.

But maybe not too many more. By raising interest rates by 0.75 percentage points in April rather than the 0.5 percentage points that economists were expecting, the Banco Central do Brasil signaled that it will be aggressive in how fast it raises the benchmark rate. That’s led some analysts to speculate that the bank could reach a target rate of 12% as early as August or September before taking a pause.

With forecasts for the rate of growth in Brazil’s economy seeming climbing every day, I’m expecting the bank to be extremely aggressive. The consensus among economists right now is for 6.3% GDP growth for Brazil in 2010. Itau Unibanco (ITUB), one of Brazil’s biggest banks, is already conspicuously above that consensus at 7.5% and Bloomberg yesterday reported that the bank is considering raising that forecast to 8.5%.

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