Improvement in BRL outlook crucial to stabilise inflation and rate expectations

While a significantly high Selic rate could theoretically help the BRL to stabilise and inflation to normalise, things are not all going to be that easy in the above-mentioned macro/fiscal scenario.

It's not even clear if Brazil should target appreciation of the real at this stage even if it appears to be the surest way of taming inflation in the medium term. BRL appreciation would damage the scope of the manufacturing revival, and given the shape of the economy, it would not be easy to achieve appreciation anyway. 

"With inflation currently well ahead of the target rate, the central bank could feel obliged to keep raising rates. The BCB is expected to raise the Selic rate +50bp to 14.25% at the July Copom meeting, leading to total tightening of 700bp in this cycle since April 2013", says Societe Generale.

Also, given the inflation uncertainty, the upside risks to our cyclical peak Selic rate forecast of 14.50% continues to rise. Not doing so would probably prompt further pressure on the currency and another round of acceleration in inflation expectations.