Brazil's currency market trended stronger Wednesday, shrugging off early-session volatility after Greek lawmakers approved a package of austerity measures that could help avoid the euro zone's first debt default.
"The market was very tense. There was an expectation that if there wasn't a deal, if [Greece] didn't approve the reforms, we could have a flight of capital out of Brazil," said Joao Querino de Santos, a trader at Sao Paulo brokerage J. Alves.
The market's mood brightened after Greece's parliament voted in favor of the measures, which were necessary in order for the country to receive the next tranche in a debt bailout package from the European Union and the International Monetary Fund. The parliament now must vote on how to implement the measures, which could prove even trickier than the vote to approve the package, analysts said.
But Wednesday's vote should help ease concerns that another global financial crisis could be brewing. EU officials have ramped up pressure on Greek politicians to approve the austerity package, saying it was the only way for the nation to avoid default on its massive debt obligations.
The real actually turned volatile in the wake of the vote, weakening from the opening quote. The currency turned at midday however, breaching the BRL1.57-to-the-dollar level that typically triggers central bank action. The central bank purchased dollars from the spot market at two auctions for BRL1.5694 and BRL1.5713 to the dollar, but was unable to contain the currency's rise against the greenback.
The Brazilian real exited active trading at BRL1.5675 to the dollar, according to Tullet Prebon via Factset. That was weaker from Tuesday's close at BRL1.5815 to the dollar.
Now that the key vote has passed, many traders expect the situation in Europe to stabilize and the real to return to its strengthening tendency. Foreign-exchange inflows, which turned negative this month amid the EU uncertainties, should also return, traders said.
"I don't think that this is going to snowball," said Cesar Roberto dos Santos, a trader at Rio de Janeiro's Previbank. The EU has too much at stake to let the Greek debt crisis get out of hand, Santos said. "Everyone is drinking at the same bar," Santos said. "I think they're going to find a solution. Maybe it won't be the best solution, but it will be one that balances the [European] community."
A debt default by Greece would be a heavy blow to not only the single-currency bloc, but also to global financial markets still recovering from the 2008 crisis. The subsequent financial chaos of a debt default would likely spread to other troubled EU countries, such as Ireland, Italy, Portugal and Spain. The countries are also struggling with heavy debt loads and sluggish economic growth.
While the next Greek parliament vote looms Thursday, local investors will now likely turn their attention to the outlook for domestic inflation and interest rates. Earlier Wednesday, the Brazilian Central Bank raised its estimates for 2011 and 2012 inflation as part of its quarterly inflation report.
The bank expects inflation to end 2011 at 5.8%, up from a previous forecast of 5.6%. Latin America's largest economy is expected to grow 4% this year. Year-end 2012 inflation, meanwhile, is expected to come in at 4.8%, up from a prior projection of 4.6%. Both inflation forecasts are above the government's 4.5% target, but within the tolerance band of plus or minus two percentage points.
The central bank, however, maintained language that suggests more interest rate hikes are on the way. The bank once again said that there's a need for a "sufficiently prolonged" monetary adjustment, a phrase which has been present in the institution's comments on inflation for several months. Investors have interpreted it as signalling the need for more interest-rate increases or alternative measures to rein in inflation.
So far in 2011, the central bank has implemented four interest-rate increases that have pushed the benchmark Selic base interest rate to 12.25%. The towering interest rates, by far the highest of any of the major economies, have proved a seductive lure for foreign investors in search of higher rates of return.
But there are signs that inflationary pressures are easing. Earlier Wednesday, the private Getulio Vargas Foundation reported that its IGP-M general price index fell 0.18% in June versus a 0.43% rise in May.
"The scenario in Brazil is improving," Previbank's Santos said. "Inflation was considered the great villain earlier this year. This month, the IGP-M shows deflation."
That means that Brazil's real will likely return to the strengthening trend seen earlier this year, which was only briefly interrupted by a series of government measures and the renewal of debt troubles in Europe.
"The [foreign-exchange rate] should maintain at this level or a little lower," Previbank's Santos said, making a call for the real at BRL1.55 to the dollar if everything "returns to normal." That would challenge the currency's recent strong point against the greenback of BRL1.5519 reached in August 2008, right before the onset of the global financial crisis.