Brazil’s economy contracted 6% y/y in the fourth quarter of 2015, facing its deepest recession since 1930s. Meanwhile, the country’s political system is being immobilized by the prevalent corruption scandal. This is preventing action to stop the quick increase in the public debt burden. Brazil’s service PMI fell to 37 in February further pressurizing the domestic economy.

Brazil’s consumer sentiment continues to be at low levels amidst increasing unemployment and a sharp drop in real wages. The nation’s investment and private consumption are likely to decline further in the coming quarters, according to Danske Bank. Moreover, the government expenditure is also likely to be a drag on the economic growth. Nevertheless, net exports are likely to add to economic growth.

“We project below-consensus real GDP growth of -3.8% and -1% in 2016-17 (consensus -3.4% and 1%, respectively)”, says Danske Bank.

Meanwhile, the Central Bank of Brazil has maintained its key interest rate at 14.25%. Inflationary pressures have begun alleviating with the real’s stabilization and rising slack in the economy. According to Danske Bank, even if there is a likelihood of further weakening of the currency, inflation is expected to decelerate further in the coming months. Therefore, there is a possibility that the central bank might cut the rate by 25bp during its next meeting in April.

The Brazilian real has continued to remain strong against the USD since September due to a surge in iron ore prices and positivity in the market regarding Roussef government’s downfall. However, it is doubtful if Roussef will step down easily in the near term that might weigh on the currency.

“Hence we expect a weakening of the USD/BRL on 3M to 4.10, but then expect it to strengthen to 3.9 in 6M and 3.8 in 12M given potential upside from the Roussef administration stepping down, increasing commodity demand from China and the BRL being somewhat undervalued”, says Danske Bank.