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Central Bank of Brazil is in a Tough Position

Brazil interest rate swaps have been steadily rising for the past six months, with 180-day and 360-day rates averaging 8.7% and 9.3%, respectively.  While the rate increases are more obvious in long-term maturities, short-term maturities are also seeing rate increases.  Both 30- and 60-day rates have climbed by 91 and 102 basis points since March 2013, respectively.

What do the rising rates mean?  Rising swap rates are indicative of market expectations that interest rates will move higher in the future.  Higher interest rates, in turn, are a reflection of the central bank’s view on future inflation.  The Brazil Consumer Price Index measures inflation at 6.7%, the highest level in nearly two years and above the Central Bank of Brazil’s target rate of 4.5% ±2.0%.  The higher spreads could mean investors expect the Central Bank to raise rates further in order to combat rising inflation.

The Central Bank of Brazil is in a tough position.  Brazil’s real GDP grew just 1.9% in the first quarter of 2013 and slowing private consumption is causing concerns for the retail sector.  In its efforts to combat inflation, the Central Bank runs the risk of raising interest rates too high and stymying growth.

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