Weekly Economic Briefings > Emerging Markets Weekly Economic Briefing

Brazil is now in danger of experiencing the kind of shock 'mega' rate hike seen last year in Turkey and Russia. The currency has lost a quarter of its value in three months and the yield curve has steepened violently. Our modelling suggests short rates might have to rise by several hundred basis points to stabilise the situation. We estimate the current probability of such a 'mega-hike' at around 30%. This would rise if the currency suffers a further significant round of losses.Using the Oxford Global Model we estimate that the depreciation seen over the last three months, if sustained, could see inflation rise above 11% and the policy (SELIC) rate rise to around 18% from the current 14.25%. The alarming rise in long-term interest rates in recent weeks suggests a crisis of confidence in the central bank's inflation-fighting policy. Neither the steady rate hikes of the last year nor alternative policies such as drawing down reserves or letting the currency 'go' may now be enough to restore credibility.Brazil's economy has entered a deep recession, which is some brake on inflationary pressures. But with foreign investors dumping Brazilian assets in the face of low growth, weak commodity prices, concerns about policy credibility and the current account deficit at 4% of GDP, Brazil's financial stability is under threat and a major policy shift may be needed to arrest the downward spiral.