Brasília cheers the real's decline For Guido Mantega, the Brazilian finance minister, last week marked the culmination of 18 months of hard work spent talking down Brazil's currency, the real. Battered by a weak domestic and global economic outlook and falling interest rates, the real has depreciated more than 4 per cent this year to about R$1.95 to the dollar, cheered on by Mr Mantega and others in President Dilma Rousseff's team. After the real touched R$1.9717 against the dollar during trade last week, its weakest since July 2009, Mr Mantega said its fall in value was "no cause for concern" while his colleague, development minister Fernando Pimentel, said it was a "good level." The decline of the real marks a tactical victory for Brazil in this phase of its "currency war," its battle against what it claims are the competitive devaluations of exchange rates by advanced economies. The question now is how much further the government is willing to let the real depreciate. While a weaker currency makes Brazil's industries more competitive, too much depreciation could reignite inflation, forcing Brazil to raise interest rates again. "The debate is whether the currency will increase inflation through the pass-through effect," says Flavia Cattan-Naslausky, a markets strategist at Royal Bank of Scotland. If Brasília is worried about inflation, it is not showing it. This year President Rousseff took up the currency war baton from Mr Mantega, personally complaining to her German and US counterparts about what she called a "tsunami" of liquidity in advanced economies. Loose monetary policy in the US and then in Europe was pursued without accompanying fiscal programmes to absorb the money. This led to excess flows into emerging markets that have inflated the value of their currencies and rendered local industry uncompetitive, Brasília argues. In the past few months, President Rousseff has backed up the currency rhetoric with an "interest rate war." The central bank has cut Selic overnight rates by 350 basis points over the past eight months to 9 per cent and is expected to cut them again to a 15-year low of about 8.5 per cent at the end of this month. While the central bank says it has done this independently based on a subdued outlook for global growth and therefore inflation, the government has played its part by reducing guaranteed returns on a popular savings scheme that were seen as putting a floor under Brazil's high rates. The policies, coupled with the central bank's buying of dollars between February and April, have contributed to an 11 per cent decline in the value of the real in three months. The fall has been so significant that some analysts are predicting the government may have had enough. Nick Chamie, Royal Bank of Canada's head of global foreign exchange strategy, wrote that the government may intervene to defend the real if it weakens much beyond R$1.98 to the dollar. "There has been an increasing chorus of finance officials suggesting that current Brazilian real levels are already supportive for local industry," he said in a report. Crédit Agricole said that further depreciation could exacerbate fears over inflation in the coming months. While industry continues to be lacklustre, Brazilian unemployment is at record lows, driving up wages and ensuring domestic demand remains strong. "We expect the dollar/Brazilian real rate to stay in the R$1.85-R$2.00 range," Crédit Agricole said. Levels beyond 2.00 would create inflation pass-through concerns that in the midst of aggressive rate cuts would intensify inflation scares in the months ahead once growth resumes. Indeed, there remain some fears that the government could overshoot in its eagerness to cut interest rates and weaken the currency. Even now, in the depths of a slowdown that has produced a contraction in domestic industrial production, inflation is far from subdued, running at about 5.1 per cent, or still above the centre of the official target of 4.5 per cent plus or minus 2 percentage points. But while the president's efforts to reduce Brazil's exorbitant interest rates are worthy, analysts point out that without underlying improvements to the country's competitiveness and lagging productivity levels, inflation will return once the country starts growing fast again. That would mean high interest rates again, which would in turn attract renewed speculative inflows from abroad. In short, a new phase in the currency war. "All of this underscores the same problem - they have too many objectives," says Ms Cattan-Naslausky. They want a weaker currency to stimulate industry but they want to cut rates at the same time and they want to keep inflation in the target band. Something has to give.