Tackling inflation? It works in Brazil

Brazil will soon be one of the major contenders for the title at the World Cup. But also in other respects it can do no harm to take an example from the country. Many countries would be jealous of the way the Brazilian central bank is controlling inflation.

The World Cup in Qatar will start in just over a month. Brazil is favorite to win the tournament, with a small lead over Argentina, according to betting agencies. A win could give the Latin American country's economy a much-needed boost. Investment bank Goldman Sachs calculated a few years ago that economic growth will increase by a few percentage points after a win at a major tournament. The local stock market of a World Cup winner is even 3,5% higher than the global average in the first month after the World Cup. In that respect, investors have little to complain about Brazil this year. With a return of over 10%, the return of the Bovespa Index is much higher than that of the world index, which fell by 25%.

The secret behind a stable real
The impressive rally of the Brazilian stock market has several causes. The large energy and mining companies are benefiting from the sharp rise in raw material prices. In addition, the shares were attractively valued after a decline in 2021. The remarkably stable real also plays a role. Since the turn of the year, the currency has appreciated by more than 5% against the dollar. By way of comparison, the euro has actually fallen by 14%. Real strength is due to decisive action by the central bank. The Banco Central do Brazil (BCDB) only officially became independent from the political system in February 2021. Chairman Roberto Campos Neto has not let the grass grow since then. He has rapidly raised interest rates from 2 to almost 14%.

Economy gets some air again
This approach appears to work: inflation has fallen from over 12% in the spring to just over 7% in September. The lower inflation gives the central bank room to take the foot off the economic brake and possibly cut interest rates somewhat in 2023. This will give the economy a little more air. But what the coming months look like depends, in addition to the World Cup, mainly on the presidential elections. On October 30, Brazilians can vote for incumbent President Jair Bolsonaro or challenger Luiz Inácio Lula da Silva. The latter is the favorite for the win after the first round of voting on October 2.

What will Lula do?
Lula also served as president from 2003 to late 2010. His previous term in office was characterized by growing government influence in business and rising government debt. These are not things that stir up much enthusiasm in the financial world. On the other hand, there is plenty of room for Lula to improve international relations. Relations with the United States and Europe have deteriorated considerably under Bolsonaro's rule. But can Lula also work well with a truly independent central bank? For now, he must first win the elections. But with a BCDB managing to push inflation down (and the World Cup approaching), now is not the time to bet against the real.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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