Brazilian Real - Order and Progress - Half Right

* Real Flags Its Value * Feel The Heavy Hand Of Brazilian Government * Likely To Trade R$2.00 to R$2.10 To The USD The Brazilian motto embellished on its flag “Order and Progress” is an exhortation of the Brazilian promise. Recently, the central bank and the government whose policies are inseparable (in spite of claims to the contrary) have held up at least one at the cost of the other. John T. Sullivan, ForexSpace.com Markets Writer, The Americas, reports. The central bank has been actively intervening in the currency market through a series of currency swaps designed to maintain a floor and a ceiling on the real’s value. According to central bank statistics, the Real has traded since early May within a narrow range of R$1.914/USD (a high on May 2nd) and a low of R$2.0897 on June 28th. Each time the real has fallen below R$2.08, the central bank has intervened through a combination of a currency swaps and/or market guidance. The reverse occurred when the real appreciated above R$2.00. Concurrent to the movements in the foreign exchange rate has been the central bank’s reduction of the SELIC rate (the monetary policy rate). The President of Brazil, Ms. Dilma Roussef, and her Administration have made it known that they want interest rates lower. Since the beginning of 2012, the central bank has accommodated this wish by lowering the SELIC rate five times from 10.5 percent to the present level of 7.5 percent. The central bank has set an annual inflation target of 4.5 percent with a 2 percent band, allowing inflation to fluctuate up to 6.5 percent or as low as 2.5 percent. In August the annualized Consumer Price Index (CPI) recorded a 5.24 percent increase. Annualized inflation in January 2012 was 6.22 percent and consistently fell through June to 4.99 percent. Thereafter, the CPI has climbed as food and beverage costs grow by double digit annualized percentages. The Brazilian government through its interaction with the central bank’s monetary policy committee is interfering with the conventional wisdom that monetary policy should be independent of politicians. President Roussef has stated she wants real interest rates to decline further. It is a noble aspiration that should be left to an independent central bank. The manipulation of short term political objectives distorts not only the workings of the domestic economy but also international fund flows. Foreign exchange rates are dependent on interest rates. These rates determine not only the comparative advantage of holding one currency against another but also the forward risk. The central bank by acceding to the government’s desire to lower interest rates has also had to intervene in the foreign exchange markets. The combination may keep order in the short term but fails to allow the economy to naturally progress. In conclusion, the Brazilian real will be controlled not so much by market forces. Rather the government’s heavy hand executing through the central bank’s operations will decide the Brazilian currency movement. The real will likely trade within the narrow band of R$2.00 to R$2.10 to the USD until both the government and the central bank have decide that the monetary policy rate is at a level sufficient to promote ongoing domestic economic growth.