Brazil's central bank meets July 20 and 21 and is expected to hike rates by 75 bp to 11%.

We note that analysts are now looking for a year-end policy rate of 12.13%, up from 12% last week and 11.75% last month. Economic data remain strong even as price pressures pick up, and so the case for more aggressive tightening is clear.

We hope that the government can institute another round of fiscal tightening in order to balance out policy and help the central bank avoid having to tighten excessively.

The state development bank BNDES is muddying the waters a bit, rejecting criticism of excessive bank lending in Brazil by saying that its lending is helping to boost investment and production.

Fitch recently warned that BNDES lending is acting like quasi-fiscal stimulus and is putting added pressure on Brazil policy-makers. BNDES' long-term TJLP lending rate has been stuck at 6% since July 2009 despite 150 bp of hikes in the benchmark SELIC rate this year, and BNDES head Coutinho ruled out any TJLP increase for now.

TJLP is set quarterly by the National Monetary Council (CMN) and last meeting was June 22, while SELIC rate is set by the Monetary Policy Committee (COPOM).

With regards to the currency, we believe USD/BRL will remain largely in the 1.75-1.90 range near-term. BRL was unable to break the 1.75 area last month, with markets nervous about other capital controls or aggressive FX intervention on any approach of 1.70.

If 1.75 is broken, there is intermediate support at 1.7205 (April low) and then 1.7155 (Jan low). While we believe further BRL gains are limited, high (and rising) interest rates are enough to keep foreign investor interest strong.

Approach of October elections is likely to lead to increased volatility over the summer, but Brazil's long-term outlook remains very strong.
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