By Peter Lavelle (from Pure FX).

Is Dilma Rousseff planning to let the real weaken?

This is one topic of conversation this week, following comments from her government that would suggest so, even as the Banco Central do Brasil defends the ‘soft’ trading band limit of 2.10 to the USD.

Speaking to local newspaper Valor Econômico last Wednesday (21st November), Rousseff said the Brazilian government was “looking for an exchange rate that is not this one, with a devalued dollar and an over-valued real.”

Then, just two days later (23rd November), Finance Minister Guido Mantega told a crowd of business leaders in Sao Paulo, “The exchange rate is at a reasonable level, still not entirely satisfactory.”

These comments set the real to the top of its ‘informal’ trading band, at 2.0985 on Friday, before the Banco Central intervened, selling $1.62bn in swap contracts to flood the market with US dollars, hence strengthening the real again.

So what reasons might the Rousseff government have for wanting to weaken the real?

The most important is a need to bolster Brazilian industry. Brazil’s manufacturing base has been hit hard by the global slowdown, with the European debt crisis in particular doing much to dent their profitability. Given that, a weaker real may help them regain competitiveness.

Furthermore, there is a perception inside the Rousseff government that the industrialised West is playing by ‘unfair rules’, with the unlimited quantitative easing being pursued by the  Fed and ECB unfairly weakening the dollar and euro against the real.

To this end, earlier this April Rousseff spoke of a “tsunami of money” coming from the West, while Mantega used his speech to the IMF in October to tell delegates, Brazil “will take whatever measures it deems necessary” to defend the real.

Yet, if there are good reasons for the Rousseff government to let the real weaken, there are equally good reasons to not let it happen. The chief of these is inflation.

Speaking this week, Wanderlei Muniz, a trader at southern Brazil’s Onnix, said that “a real weaker than 2.15 threatens to ignite inflation.” That will of course eat into Brazilian consumers’ purchasing power, and in itself diminish growth.

This perhaps explains why, following Mantega’s remarks in San Paolo last Friday, the Banco Central intervened to strengthen the real, and so prevent inflation spiralling beyond its control.

The Banco Central currently pursues an inflation target of 4.5%, with 2.0% leeway either way. In October, it was at 5.45%, toward the upper end of that target.

So will the Rousseff government let the real weaken or not? If it does, it’s clear there will be a price to pay, in the form of inflation. It’s just a question then of whether that’s a cost Brazil’s government is willing to accept.

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