Slowdown in Brazil and Interest Rates Decision

Today it was released the data regarding the contraction of the Brazilian economy in Q1. The economy shrank less than expected in the first quarter, increasing the bets that central bank will slow the pace of interest rate cuts. Output decreased by 1.8% from a year ago and 0.8% with rrespect to Q4 2008. In turn, because this is the second straight quarterly of contraction we can say that Brazil has formally entered a recession, for the first time since 2003. Different from the Bloomberg consensus, we were not forecasting a worse number.

The fact is that this smaller contraction may impact the upcoming monetary policy decision. In our view, the Central Bank may decrease rates by 0.5% tomorrow from 10.25%. That would be the smallest cut this year. In turn, interest rates would be 9.75%. The first reason is the smaller contraction, suggesting that the economy may be recovering soon. Besides, given that the economy is on the track towards recovery it makes little sense for the Central Bank to implement a larger interest rate cut and then latter, have to hike again to avoid an overheated economy. The fact is that this crisis enabled Brazil to achieve a low real interest rates. This is important for a variety of reasons. One of them is that the low rate of investment in Brazil is always explained by the high rates of interest rates that do not stimulate the capital to be allocated towards the productive use of capital. Now, with lower rates, investors will have enough incentive to invest in the productive sector of the economy. This will allow the country to solve a set of bottlenecks in a wide range of sectors, like infrastructure. Besides, a low and stable interest rate also should incentive the widespread use of long term credit. The fact that we lived for a very long time with high rates deprived consumers from having access to credit. Now, with low rates, we will be able to have access to cheap access to credit.