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Central bank actions delay recovery in Brazilian equities

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Coutts has downgraded its view of Brazilian equities following the increase in interest rates, signal of further rate rises to come and weaker-than-expected growth, says Gary Dugan, CIO for Asia & the Middle East…

We are downgrading our view of Brazilian equities following the decision by the monetary policy committee of the Brazilian central bank (Copom) to increase interest rates by 50 basis points (bps) last week, and its signal that there are likely to be further rate rises to follow. There is a risk Copom will raise policy rates by a further 100bps over the summer.

Our previous view that Brazilian equities would start to rebound after a prolonged period of underperformance was based on the view that an end could be seen to the trend of rising interest rates. In the event, the central bank has been far more hawkish than we or the market expected.

The rise in interest rates was a reaction to persistently higher-than-targeted inflation. Brazil’s inflation rate has accelerated for nine straight months through to March 2013. It has settled at 6.5%, at the very top of the central bank’s target range of 2.5-6.5%.

Growth has also disappointed and, had inflation been lower, the central bank might have been more minded to cut rather than raise rates. Last week’s first-quarter gross domestic product (GDP) report was well below expectations, with reported year-on-year growth of 1.9% against forecasts of 2.3%. Brazil is suffering from subdued consumer spending and weak exports. Exports fell 23.2% quarter-on-quarter on an annualised basis.
The cocktail of weak growth, higher interest rates and weakening currency will keep the equity market under pressure. However, we don’t see substantial downside given that Brazilian equities have performed so poorly already this year: Brazil’s Bovespa index has fallen 13.4% since the start of the year whereas the S&P 500 index of US shares is up 12.8%.

We understand that institutional investors are already underweight Brazilian equities. The actions of the central bank would benefit Brazilian financial markets in the medium term if they prove effective in bringing down inflation. However, investors may not be interested in buying until there is greater transparency about the timing of the peak in interest rates. US mutual funds that invest in Brazil have seen their 14th straight week of outflows – the longest period of outflows on record.

 

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