The Central Bank of Brazil (BCB) raised its key interest rate by 50 basis points. Analysts at Wells Fargo believe policymakers will opt for a 25 bps rate hike in September and take the Selic rate to 14.00%. They forecast the USD/BRL exchange rate to reach 5.75 by the end of this year, and 5.95 by year-end 2023.

Key Quotes: 

“While we have revised our Selic rate forecast higher, we still believe the outlook for the Brazilian real will be challenging going forward. We share the BCB's concerns of fiscal policy and believe Bolsonaro-led increased social spending will materialize and weigh on the currency ahead of the election. Right now, we would argue Brazil's debt trajectory is still unsustainable. Should Bolsonaro extend spending that is not fiscally prudent or evades the spending cap, market sentiment toward Brazil is likely to turn negative. This is our base case scenario for the Brazilian real, and in the short term, we believe the USD/BRL exchange rate can reach BRL5.75 by the end of 2022 on risks tied to the election.”

“We also believe that increased fiscal spending is likely to become more permanent going forward, regardless of the outcome of the election as both Bolsonaro and Lula have suggested their preference is to eliminate Brazil's fiscal spending cap altogether. We believe this capital flight scenario could pick up momentum over the longer term and the Brazilian real is likely to suffer the consequences.”

“With Brazil's economy already likely on the path toward recession by the end of this year, BCB policymakers are likely to be the first major emerging market central bank to unwind interest rate hikes. As fiscal risks persist well into 2023 and the BCB lowers its Selic rate, BRL depreciation is likely to continue. In that context, we believe the USD/BRL exchange rate can reach BRL5.95 by the end of 2023.”