Brazil cuts interest rates, stock market gets a boost

Selic rate evolutionEnlarge GraphBrazil operates under an inflation targeting system, therefore the Copom  (Brazilian Monetary Policy Committee) must make the trade-off between lowering the reference interest rate to boost growth or raising it to hold back inflation. The Copom holds 2 day meetings 8 times a year and its duty is to set up an interest rate that will lead to the set inflation targets. After the meeting, the Central Bank releases a short statement stating the new overnight target policy rate, known as the Selic Rate. Generally this has a very high impact on the market, very similar to the impact of the Federal Reserve rates announcement in the US market1.

The economy as a whole is affected by changes in the Selic rate since it affects the funding costs of banks and hence the funding costs of companies, which changes how much capital companies can invest in growth.  For example, homebuilders are negatively affected by increases in the Selic rate since it increases the cost of borrowing for both the builders and the investors and hence it limits the amount of capital to invest leading to a slowdown in housing starts and profitability for the industry.

The Brazilian Central Bank released the minutes of the latest Copom minutes earlier this month. This is an important event that holders of Brazilian equities, such as iShares MSCI Brazil Index Fund (EWZ), should follow.  The committee decided to reduce the Selic rate to 7.25% from 7.50% with a tight voting win of 3 out of 5 votes. This should fuel short term growth in the economy and calm any potential inflation fears.

The reduction in the Selic may be taken as a sign of confidence from the government that inflation is under control and that the economy can continue to expand in the short term without risk of overheating.  The contrarian view of course, would be that the Copon is worried about a slowdown, but nonetheless the reduction may still spark growth.  EWZ holders can feel confident of good prospects in the short term.

  1. As background, the US federal funds rate, known as the Fed rate, is the interest rate charged by banks to borrow overnight funds from other member banks of the Federal Reserve.