Bloomberg.com:Brazilian Real Volatility Falls on Central Bank Sales (Update1)

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Brazilian Real Volatility Falls on Central Bank Sales (Update1)

By Min Zeng

Jan. 26 (Bloomberg) -- Brazil's real, the nation's eighth currency since World War II, has become less volatile than the British pound, Swiss franc and Norwegian krone.

The central bank has limited price swings to the smallest in six years by buying dollars every day since July, according to JPMorgan Chase & Co. data. Policy makers want to limit gains to protect exporters and boost growth after a 66 percent surge in the real in the past four years.

The decline in volatility is spurring demand among foreign investors for Brazilian bonds, making it cheaper for the country to borrow abroad and giving domestic companies confidence to commit to longer-term investments. Brazil devalued the real by one-third in 1999.

``These days when companies make their forecasts they work with a scenario of exchange-rate stability,'' Luiz Fernando Furlan, Brazil's trade minister, said in an interview in Davos, Switzerland. ``Those that are investing and exporting aren't getting caught by surprise. The opposite happened in the past.''

Traders expect the real to fluctuate 6.4 percent against the dollar on an annualized basis over the next month, based on currency options prices. By contrast, the British pound will swing 6.55 percent, the Swiss franc 6.5 percent and the krone 8.65 percent, options show.

`Kill Volatility'

One-month implied volatility for options on the real has declined from 15 percent in July and from about 34 percent in May, the highest since Bloomberg began compiling the data in October 2003. Traders quote implied volatility, a measure of expectations for price swings, to set prices for options.

``The central bank is trying to kill volatility,'' said Tony Volpon, a strategist and chief economist at Sao Paulo-based stock and futures broker CM Capital Markets. ``I don't think the central bank is going to back off from buying the dollar in the market over the next six months.''

The real, which Brazil introduced in 1994, traded at 2.134 per dollar at 10:50 a.m. in New York. Options are contracts that grant the right to buy a specific amount of a security within a pre-set time period.

The real has surged since President Luiz Inacio Lula da Silva took office in January 2003, posting the biggest gain over that time among the 69 currencies Bloomberg tracks against the dollar. A boom in prices of commodities that Brazil exports, such as orange juice and iron ore, fueled the gains. The currency rally now may threaten those exports, making it harder for the government to spur economic growth.

Crawling Peg

For the year, the currency is flat against the dollar. The real and the pound are the only currencies not to have fallen against the dollar this year among the 16 most actively traded.

Implied volatility for the real has fallen to the lowest since October 2000, according to Tim Owens, managing director of JPMorgan's currency and commodity solutions group in London.

Brazil let the real float freely the year before that, in January 1999. From 1994 to the end of 1998, the central bank orchestrated a gradual weakening of the currency, a system known as a crawling peg.

The central bank's dollar buying has held the real to a 1.4 percent gain since mid-2006, after an 8 percent rally in the first half of last year. The currency has traded in a range of less than 0.12 real since July, about one-third its fluctuation the prior six months and a fifth of its 2005 swing.

Officials at the central bank weren't immediately available to comment, said Jocimar Nastari, a bank spokesman in Brasilia.

Increasing Reserves

In an effort to increase international reserves, the central bank has bought dollars on the spot market every day since July 3. Brazil's reserves have increased to a record $89 billion, from $57 billion a year ago.

Analysts such as Volpon say the dollar buying is an effort to slow the real's gain and help sustain export growth.

``Low volatility tends to be associated with promotion of trade,'' said Paulo Leme, managing director for emerging markets at Goldman Sachs Group Inc. in Miami.

Exports will probably rise to a record $152 billion this year, Ivan Ramalho, deputy trade and development minister, said earlier this month. Brazilian exports increased to an all-time high of $137.5 billion in 2006, Ramalho said.

Brazil's high interest rates, and a benchmark stock index that has tripled in the past five years as commodity prices soared, have stoked foreign demand for the real.

The real-denominated bond maturing in January 2008 yields 12.49 percent, compared with about 5.1 percent for the U.S. Treasury security maturing that month. The inflation rate in Brazil is 3.1 percent, while the U.S.'s is 2.5 percent, as measured by consumer prices.

The real will probably trade in a range of 2.12 per dollar to 2.17 per dollar over the next six months, Volpon said.

The smaller currency swing gives international investors even more confidence to buy Brazilian assets.

``They have the insurance against currency risks,'' said Leme. ``Low volatility reduces their need for hedging.''

To contact the reporter on this story: Min Zeng in New York at mzeng2@bloomberg.net .

Last Updated: January 26, 2007 10:57 EST