August 3, 2008 / 3:12 PM / in 10 years

EMERGING MARKETS WEEK-Latam inflation eyed for currency impact

NEW YORK, Aug 3 (Reuters) - Latin American inflation data this week will yield clues on how many interest rate increases are on the cards, bearing on the strength of the region’s currencies.

Wall Street expects Latin American central banks to keep raising rates this year to combat rising inflation though it is uncertain as to how high rates will peak. Higher rates typically lure foreign cash and strengthen currencies.

“We see EMEA (European, Middle Eastern and African) central banks as reaching the end of their (monetary) tightening cycles, whereas there is still more to go from Latin America,” wrote Barclays Capital on Friday.

The most closely anticipated regional inflation reports for July will be that of Mexico, due on Thursday, and Brazil’s benchmark inflation data, scheduled for release on Friday.

“You’re going to be on the inflation watch next week, especially with the two biggest countries in Latin America, Mexico and Brazil,” said Enrique Alvarez, IDEAglobal’s head of emerging market research in New York.

Mexico's peso MXN= has strengthened nearly 10 percent against the dollar this year as the central bank has raised its benchmark overnight rate to 8 percent, heightening its yield appeal vis-a-vis the United States, where the equivalent rate is 2 percent.

The 6 percent spread between benchmark U.S. and Mexican rates is the widest since 2005. On Friday, the peso traded at fewer than 10 pesos to the dollar for the first time since 2002.

In Brazil, the real BRL= is at 9-1/2 year highs, having strengthened about 14 percent against the dollar in 2008 as the country raised its benchmark Selic rate to 13 percent.

The consumer price index reports can also reverberate in those countries’ domestic bond markets, and in turn bolster the currencies.

“Look for (Friday’s Brazil) CPI data to give the market the excuse it’s looking for to take short (bond and futures) rates higher,” wrote the Royal Bank of Canada. An increase in short-term bond rates typically strengthens a country’s currency.

The sole central bank in Latin America due to formally consider raising rates next week is Peru, which on Aug. 1 reported a 0.56 percent rise in CPI.

The reading reinforced Wall Street expectations that the country’s central bank would Thursday raise its benchmark rate by a quarter-percentage point to 6.25 percent.

“Expectations for additional monetary tightening and positive (economic) fundamentals still support our expectations for the (Peruvian sol) to remain strong,” wrote Deutsche Bank on Friday, commenting on the July inflation data.

Peru's sol PEN= has strengthened about 6 percent this year against the dollar as the central bank has raised its benchmark rate by 1 percentage point.

On Tuesday, Chile reports CPI data for July and its June IMACEC economic indicators.

“This week’s economic data, that is elevated inflation and modest economic growth, should clarify to what extent the central bank will likely raise the monetary policy rate in its next meeting scheduled for August 14th,” IDEAglobal said in its Chilean forecast for the coming week.

However, some analysts say a weak IMACEC result could act as a damper on the Chilean central bank from raising rates this month, analysts say. Currently, Chile’s central bank overnight rate is 7.25 percent.

Still, the direction for rates in the region overall appears clear, analysts say.

“Until we become closer to a peak in interest rates across Latin America (only Colombia looks close), the region’s currencies look set to remain supported,” wrote HSBC.

Also on investors’ radar will be the policy statement on Tuesday from the Federal Reserve’s Federal Open Market Committee, which sets interest rates.

Markets widely expect no change in the benchmark overnight federal funds rate, now at 2 percent.

Rather, attention will focus on any change in emphasis on its economic outlook, particularly regarding inflation.

A greater stress on inflation concern could send U.S. Treasury yields higher and in that case, would probably briefly reduce risk appetite for investing in emerging markets assets, said Alvarez.

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