Brazil: the cooperation between the new government and the Central Bank will be decisive.

■　Brazil's Central Bank keeps policy rate unchanged but maintains caution about rising inflation ahead. 

■　Brazilian markets since the end of October have been weighed down by concerns about the new government's fiscal policy management.

    At its Monetary Policy Committee (COPOM) meeting that ended on 7 December, the Brazilian Central Bank (BCB) left its policy rate unchanged at 13.75% for the third consecutive meeting. However, in a statement, the BCB said that "the Committee will closely monitor future fiscal policy developments and their impact on asset prices and inflation expectations in particular", pointing out that uncertainty surrounding fiscal policy could lead to higher inflation. BCB Governor Neto also mentioned on 18 November that the BCB may resume the interest rate hike cycle, depending on the spending plan to be passed by Parliament in the coming days, and it is striking that the BCB side has emphasised its caution regarding the new Lula Government, which will start from the beginning of the year.

    Similarly, the financial markets appear to be interpreting this as a headwind amidst concerns over the fiscal policy management of the new Lula administration, with the Bovespa index confirming -10.8% between the end of October and 13 December. The yield on Brazilian 10-year government bonds rose to 13.88% at one point, the highest level since April 2016. The real also weakened against the US dollar from the high R$5.17s to the low R$5.29s and against the yen from the high ￥28s to the mid ￥25s.

    This concern is seen as a warning about the track record of the left-wing, pro-balance policies of the government in power from 2003 to 2016, which exacerbated the subsequent recession. And in the intervening period, 2003-2011, President-elect Lula was in power, and with the announcement of the new Government's key ministers on 9 December, market attention will now turn to specific fiscal policies. Given the traditionally deficit-ridden nature of left-wing governments in the Latin American region, there is a risk that financial markets and the BCB may remain wary for longer than expected.

    The current economic indicators are showing mixed results, but a significant recession is not expected at this stage: the unemployment rate for August-October was 8.3%, the lowest level since July 2015, and the trade surplus for January-November totalled USD 58 billion, higher than in the same period last year (USD 57.4 billion). On the other hand, the current account deficit in January-October reached a cumulative USD 44 billion, making it easy to be aware of the 'twin deficits' of the fiscal and current account deficits. In addition, real GDP grew by 0.4% y-o-y in the July-September period, which was below market expectations (+0.7% y-o-y). Whether or not the environment surrounding the Brazilian market will improve next year will depend on the cooperation between the new Lula Government and the BCB, which wants to cut interest rates; an early interest rate cut by the BCB is expected to lead to a positive turnaround in the Brazilian market.