Steady Brazil overnight rate bodes well for debt-holders, says Deutsche Bank economist

By Reshmi Basu and Paul A. Harris

St. Louis, June 17 - The decision by Brazil's central bank to leave interest rates unchanged has positive implications for holders of the nation's debt, according to Gustavo Canonero, Deutsche Bank's chief economist for the Latin American sector.

Late Wednesday Brazil's central bank, Copom, unanimously voted to leave overnight interest rates unchanged at 16%.

"It reflects an economy that is confirming evidence of a strong recovery," Canonero told Prospect News during a Thursday interview.

"At the same time it's reflecting an inflation threat that is marginal."

Canonero said that Deutsche Bank is projecting Brazil's 2004 growth at 3.8% and is projecting inflation of 6.7%, which, he added, is slightly above the central bank target.

"This is not bad news for debt-holders, because Brazil is in a relatively strong recovery where you are seeing some push in domestic prices in response not only to growth in the economy but also to the commodity-inflation that we are seeing around the world."

Canonero said that Deutsche Bank expects the initiative from the government of president Luiz Inacio Lula da Silva to increase the minimum wage, now before the Brazilian senate, will eventually be passed.

Aside from labor costs that are possibly on the rise, inflationary pressure from rising crude oil prices is also being felt in Brazil.

Having stalled for as long as it could, Petrobras announced early this week that gasoline refinery prices would be raised by 10.8% and diesel refinery prices by 10.6%.

Brazilian consumers can expect to take an approximately 4.5% hit for gasoline and 6.4% for diesel, as a result of the first increase in fuel prices announced by Petrobras under the Lula government.

"I think those factors are right now priced into Brazil debt," Canonero asserted.

"What is of greater concern for the market is the global emerging markets picture ahead of a rate-tightening cycle in the U.S."

Sell off seen overdone

Not long before noon Thursday, Canonero spotted Brazil's benchmark 11% bond due 2040 at 92.55, unchanged from the previous day's close.

In late afternoon trading, the bond was trading at 93.250, up 1.10.

"You have had an adjustment already," Canonero commented. "The market has been looking backwards and seeing that maybe that adjustment was too much.

"Brazil's debt has performed relatively well over the past two weeks following a sustained period during which it sold off. I think its stronger performance over the past two weeks is a reflection of people's comfort with regard to the present levels.

"I think people are getting used to the likely U.S. interest rate scenario. And what really matters to people is the return you get from emerging markets in a stable environment.

"That is what is likely to give some support to the market."

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