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Brazil: Back to the politics - Nomura

According to Joao Pedro Ribeiro, Research Analyst at Nomura, as the central bank’s cutting cycle nears its end, the focus has increasingly shifted back to (very uncertain) short- and medium-term political scenarios in Brazil. 

Key Quotes

Activity: Prospects for growth have improved throughout the year, despite remaining somewhat mediocre because of the size of the collapse in economic activity over the past three years. Q2 GDP data q-o-q show that the economy expanded for a second quarter, albeit slowly, which we believe solidifies the recovery in 2017. Unlike Q1, when growth was strongly driven by the agricultural sector, growth in Q2 was a bit more broadly based. However, Q3 data have shown both ups and downs in some of the leading growth indicators, tempering our take on short-term activity. For now, we keep our yearend forecasts unchanged at 0.6% y-o-y (2017) and 2.3% y-o-y (2018).”

Inflation: October IPCA inflation surprised to the downside, at 0.42% m-o-m (versus consensus of 0.49%). With this result, 12-month inflation rose from 2.54% y-o-y to 2.70%, still below the lower boundary of the Central Bank’s target (3.0%). Although there has been some normalization of monthly inflation in the past few months – in line with our view of a slight pickup in yearly readings in Q3 – we believe risks continue to be tilted to the downside, not only for the remainder of 2017, but also into 2018.”  

Policy: Last month the Central Bank of Brazil (BCB) released the minutes from its 25 October policy meeting, in which it cut rates by 75bp to 7.50%. The document confirms the very short-term plan of a 50bp cut in December, as had already been signaled in its post-meeting communiqué. However, the BCB also provided new information on its thought process, which suggests an increased likelihood of additional cuts early next year to below 7.0%. The minutes do not change our view of stable rates at 7.0% throughout 2018, but the downside risks, which already existed to the endpoint of the cycle, now appear to be bigger – especially taking into consideration our generally dovish view on inflation into next year – and positive developments relative to the BCB’s scenario could very well nudge the Bank into additional cutting in February.”

Risks: The continued political uncertainty is still very much the case and has gained relevance in the outlook in the past few weeks. The short-term focus is back on the probability of the government passing social security reforms in Congress. We do not view this as a base case, but we still attach a reasonable probability (of broadly 25-35%). In the medium term, the focus is likely to be on the 2018 October presidential election. Here, uncertainty has risen significantly, in our view, together with tail risks. We see little clarity on whether former President Lula will be deemed eligible to run, which could be a relevant market factor in Brazil. Further, we believe the lack of a strong candidate in the center of the political spectrum continues to leave room for less mainstream alternatives.”

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