May 31, 2013 / 1:56 PM / 5 years ago

UPDATE 3-Brazil real hits 4-year low, interest-rate futures rally

* Brazil real slumps on risk aversion, cenbank intervenes

* Selic increase by 50 bps sends rate futures rallying

* Markets see turning point in fight against inflation

By Walter Brandimarte

RIO DE JANEIRO, May 31 (Reuters) - The Brazilian real closed at a four-year low on Friday despite central bank efforts to support the currency, while interest-rate futures rallied after policymakers raised the benchmark Selic rate by more than investors expected.

The real ended at 2.1412 per dollar, its weakest level since May 2009, even after the central bank stepped up its campaign against inflation, a move that potentially increases the appeal of Brazilian fixed-income assets.

Currency losses were triggered by a combination of global risk aversion related to a possible withdrawal of U.S. stimulus measures and speculation by local investors about policymakers’ tolerance to a weaker currency.

Not even a central bank intervention earlier on Friday was able to prop up the currency. The bank sold currency swaps, derivative contracts designed to strengthen the real, but the auction only temporarily cushioned the real’s decline.

A weaker currency is a headache for the central bank as it could add to inflation by making imported goods more expensive. A sharp depreciation of the real could also increase currency risks to companies exposed to exchange rate fluctuations.

For now, however, government officials might just be giving some time for investors to digest a series of market developments domestically and abroad.

In an interview with Reuters, a government source said policymakers “have to wait and see what is going to happen” to the U.S. bond-buying program, which for years has provided a steady source of dollars seeking higher returns in emerging markets.

A higher-than-expected increase in Brazil’s Selic rate also “tends to mitigate” the depreciation of the real, the source said.

“It’s still early to say at which level the central bank wants the real to trade, especially after (finance minister Guido) Mantega said a weaker currency is good for exporters, which caused all that speculation,” said Glauber Romano, a trader with Intercam brokerage in Sao Paulo.

“But the central bank is already signaling it won’t allow the real to weaken much further,” Romano added.

INTEREST-RATE FUTURES RALLY

Brazilian interest-rate futures rallied, however, after the central bank’s decision to speed up the pace of monetary tightening was seen as a turning point in the bank’s fight against inflation.

Brazil’s central bank on Wednesday evening lifted the Selic by 50 basis points to 8.0 percent in a unanimous decision announced hours before the start of a national holiday on Thursday, which shut financial markets.

Ahead of the announcement of the decision, many economists and investors had bet policymakers would keep raising borrowing costs at a more modest pace as economic activity falters.

“The acceleration in the rate hike pace and a unanimous decision shows a surprising resolve of the central bank to renew focus on inflation,” Siobhan Morden, head of Latin America strategy at Jefferies and Co, wrote in a research note.

While yields paid on short-dated interest rate contracts are surely going to rally, the real question is whether investors will continue to ask for more inflation premium in the longer-dated contracts, Morden said.

So far on Friday, the shape of Brazil’s domestic yield curve remained little changed, with the most liquid contracts rising in block.

Interest-rate contracts maturing in January 2014, one of the most traded, jumped 36 basis points to 8.42. Longer-dated contracts expiring in January 2017 also rose 36 basis points, to 9.74 percent.

Brazil’s yield curve now prices in at least another Selic hike of 50 basis points in July, according to Reuters’ calculations. Some analysts said an additional and final rate hike of 25 or 50 basis points could also be on tap.

That is a sign that investors expect policymakers to aggressively fight inflation even after key GDP data on Wednesday showed Brazil’s economy expanded 0.6 percent in the first quarter, less than the 0.9 percent forecast by economists.

Responding to concerns rate hikes could hurt growth, central bank chief Alexandre Tombini on Thursday said in a TV interview the central bank’s move will increase investors’ “confidence in the pillars of the Brazilian economy,” helping in the economic recovery.

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