(Bloomberg) -- Major Wall Street firms warned that Brazil’s worsening fiscal outlook is putting pressure on central bankers to accelerate their tightening pace and deliver a bigger-than-expected interest rate hike next week.
JPMorgan Chase & Co., Goldman Sachs Group Inc, Credit Suisse Group AG and Morgan Stanley all raised their forecasts for interest rates since Thursday and now see policy makers led by Roberto Campos Neto raising the benchmark Selic rate by at least 125 basis points on Wednesday to 7.5%. Analysts at UBS BB and Barclays Plc expect a 150 basis points hike.
The banks say higher rates are going to be needed to offset inflation pressure created by President Jair Bolsonaro’s pledge to boost cash transfers to the poor despite warnings that the government can’t afford it. To pay for the new aid, the government will have to seek a change to a spending cap rule that is seen by investors as one of the last anchors of fiscal stability for the developing nation.
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Brazil’s interest rate curve steepened after the announcement of the new aid program. Options now imply an 83% chance policy makers deliver more than the 100 basis point increase they pledged next week, up from about 40% on Thursday, according to data from local exchange B3. Traders are moving bets toward 150 basis points, which would be the biggest rate hike in two decades, and also wagering the Selic will reach as much as 11.5% at the end of the tightening cycle.
Investors “reached a tipping point,” wrote analyst Alberto Ramos at Goldman Sachs. The government’s efforts to bolster cash transfers are eroding a key spending anchor, he said.
Economy minister Paulo Guedes, who lost four members of his team amid disagreements over the extra spending, defended the aid on Friday, saying Brazil’s fiscal framework hadn’t changed. He also said the central bank, which gained formal autonomy earlier this year, can’t stay behind the curve.
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“If everything is rising, then the focus needs to be on the central bank,” he said on Friday in a press conference with Bolsonaro.
Brazil’s monetary authority has been among the most aggressive in the world, raising rates by 425 basis points to 6.25% since March. They had signaled their third consecutive full percentage point increase for next week.
Inflation has been spiraling above target for months in Latin America’s largest economy, driven by higher food and fuel prices. Consumer-price inflation reached 10.25% in September. The central bank targets inflation at 3.75% this year and 3.5% next.
“If in the next 72 hours there is no commitment by the government and the congress to contain the additional cash transfers around 30 billion reais next year, the Copom could well start a more aggressive tightening cycle by moving at least 150 basis points,” wrote in a research note Cassiana Fernandez, chief Brazil economist for JPMorgan. If not, they risk losing control over inflationary expectations as the currency depreciates, she added.
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