Wednesday, March 7, 2012

Brazil Slashes Interest Rates For Fifth Time

It wasn't surprising that Brazil slashed interest rates for the 5th time tonight, but it was a little surprising to see a 75 basis point cut. One needs to understand though that Brazil still maintains one of the highest interest rates in the world after this cut to 9.75%. This even after 275 basis points of rate cuts in the last 6 to 7 months.

After a 2.7% GDP print for 2011, its just natural that the interest rate would drop from such lofty levels. What is ironic is that the original surprise cut back in August last year was so criticized. Just imagine now if the central bank hadn't started so soon. This economy might be headed to a recession if not for the fast action.

One also needs to understand that interest rate cuts take up to 9-12 months to have an impact on the economy to a great extent. The original cut was only some 7 months ago. Though this does further highlight the typical problem with rate cuts. The Brazilian central bank has already made 5 rate cuts before the first one has even had the chance at impacting the economy.

Of course, they don't have much of an option with rates above 10%, but this also highlights the issues with raising rates to lofty levels in the first place. When will central banks learn that slow measured changes are the best medicine?

Another issue I'd like to further understand is why Brazil has such a structurally high interest rate. If the rate in Columbia stands at 5.25%, it doesn't add up that Brazil would be roughly double on a continual basis.

Look for stocks like Gafisa (GFA) and Gerdau (GGB) to see a lift from the lower rates tomorrow. Wireless provider NII Holdings (NIHD) might see a smaller bump from the rate cut, but the stock now trades around 52 weeks lows even after the other rate cuts. 

 Details from CNBC report:

  •  In what could be its most controversial move since a surprise rate cut in August, the central bank lowered its benchmark lending rate to 9.75 percent from 10.50 percent in a split decision. Two of the bank's seven directors voted for a smaller rate cut to 10.0 percent.
  • "Generally the central bank slows the rhythm (of interest rate cuts) when it's near the end of a cycle, but now it's accelerating. We can expect more cuts to the Selic rate," said Eduardo Velho, chief economist with Prosper Brokerage.   
  • Official data on Tuesday showed Brazil's economy grew just 2.7 percent in 2011 after barely avoiding a recession in the second half of the year. That was a far cry from 2010, when the economy grew 7.5 percent, the fastest pace in more than two decades. 
  • In theory, lower rates would help limit capital inflows by reducing the returns of investors seeking higher profits in emerging markets. But even at 9.75 percent, Brazilian interest rates would remain among the world's highest.  
  • Inflation slowed to an 11-month low of 6.22 percent in January. Analysts see annual inflation easing further to 5.84 percent in February.
  • Rates in Brazil are much higher than those of regional peers such as Mexico and Colombia where rates stand at 4.50 percent and 5.25 percent respectively.

Disclosure: Long GFA and NIHD. Please review the disclaimer page for more details. 


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