Merrill sees Brazil interest rate supporting real

Fri Feb 29, 2008 4:28pm EST
By Elzio Barreto
SAO PAULO (Reuters) - Brazil's real will remain "well anchored" in 2008 as high domestic interest rates lure overseas funds, offsetting an expected current account deficit this year, Merrill Lynch & Co's head of global currency strategy said in an interviewed.
The real BRBYmay strengthen to 1.6 per dollar in March before weakening toward 1.8 per dollar by the end of 2008, said Daniel Tenengauzer, head of global currency strategy at Merrill Lynch. The currency, which gained 20 percent in 2007 and is up 5.5 percent so far this year, traded at 1.686 on Friday.
Brazil's real interest rate, or the rate discounted for inflation, is among the highest in the world at 6.5 percent, luring fixed income investments.
Dollar inflows into local bonds and derivatives should help support the real even as the country posts its first current account deficit in six years in 2008, Tenengauzer said in an interview.
"Given where the current account is, given how high real interest rates are, the combination of these two make the currency still quite exciting," he said.
"Unless the current account really deteriorates a lot between now and the end of the year, the currency should remain very well anchored," he said.
The central bank forecast Brazil will post a $3.5 billion current account deficit in 2008, compared with a surplus of $3.35 billion last year and a surplus of nearly $14 billion in 2005. The expected deficit this year is not a concern because Brazil is growing at a robust pace and needs imports of machinery and consumer goods, Tenengauzer said.
INTEREST RATES
Brazil's central bank is expected to keep the Selic overnight lending rate at 11.25 percent next week for a fourth straight monetary policy meeting in order to keep inflation at bay, according to a Reuters survey of 29 economists.
Brazil's stable interest rate contrasts with a decline in borrowing costs in the United States and expectations of rate cuts in Europe. That raises the appeal of the real to carry-trade investors who borrow in currencies with low funding costs such as the Japanese yen to buy high-yield assets.
"It's not about the carry trade, it's about how much you get remunerated for the risks that you're taking," Tenengauzer said. "In Brazil I'm getting remunerated with the second highest real interest rate in the world for a country that is effectively in balance."
Still, Merrill Lynch expects the real to lose some steam by the end of 2008 as Brazil's trade surplus slips and the central bank cuts borrowing costs.
"We do believe that the real will weaken toward the end of the year but we don't see that as the end of the world," Tenengauzer said. "We still see this as a good environment for the Brazilian real, at least for the next few months."
(Editing by Jonathan Oatis)