2 Reasons Brazil's Central Bank Is Expected To Raise Key Interest Rate

Earlier this year we saw Brazilians take to the streets to protest poor public services and rising costs. The erosion of income by higher inflation is certainly a deep rooted issue in Brazil.

Then there's the weakness in the Brazilian real, down 20% against the greenback. The real is now one of the worst performing major emerging market currencies.

Consumer prices in Brazil slowed to 6.27% in July, led by a marked cooling in the price of food and transportation. While the overall level is still high, it is within the upper end of the central bank's range.

Though July's headline number suggests inflation is now trending down, the central bank will have to factor in weakness in the Brazilian real which will only add to inflation concerns.

With that in mind, Brazil's central bank monetary policy committee (Copom) is expected to raise its benchmark Selic lending rate by 50 basis points to 9%.

"Even the BCB’s conservative passthrough coefficient of 0.5 (for 10% depreciation of the currency) implies at least one full percentage point support to IPCA inflation," writes Dev Ashish of Societe Generale. "With our less conservative estimate of this coefficient between 0.8 and 1.2, we believe that inflation will actually be 2% points higher due solely to exchange rate depreciation."

Brazil already unveiled a $60 billion cash-and-insurance program to bolster the real.

Concerns about 1. The Fed tapering its asset purchase program. 2. Brazil's economic growth 3. The current account deficit are expected to continue to "exert inflationary pressures" through the first half of 2014.