Brazil's currency strengthens after central bank rate hike

By Marcela Ayres

BRASILIA, Sept 19 (Reuters) - The Brazilian real opened higher on Thursday a day after the central bank raised its benchmark interest rate, diverging from the U.S. Federal Reserve, which began its anticipated easing cycle.

The currency rose more than 1% against the U.S. dollar early in the session before paring gains, but still extending its recent strengthening trend.

Policymakers in Brazil hiked rates by 25 basis points on Wednesday to 10.75% and signaled more increases ahead to address a challenging inflation outlook driven by stronger-than-expected economic activity.

Although Brazil's move was widely expected by the market, the Fed's bold decision to cut rates by half a percentage point effectively widened the interest rate differential between Latin America's largest economy and the United States.

That is likely to support the Brazilian real by attracting capital inflows and easing inflationary pressures through lower import prices.

This outlook had already provided relief to the country's currency, although it has still weakened by more than 10% compared to the U.S. dollar year-to-date.

Alvaro Frasson, a macro strategist at BTG Pactual, said he expected two more rate hikes of 50 basis points this year in Brazil but said the Fed's action could allow the country to tighten borrowing costs less aggressively.

"Given the surprise from the Fed and the room the central bank left open in its statement, it seems there's a downside bias to the magnitude of Brazil's rate hike cycle," he said.

Meanwhile, C6 Bank said the central bank hinted in its statement that the 25 basis-point pace might be insufficient going forward.

This is because, even factoring in the market's expectations of same-size increases over the next three policy meetings through January, the inflation projected for six quarters ahead - currently the central bank's target horizon - rose to 3.5% from 3.4%, moving further away from the official 3% goal.

"The committee seems to be suggesting a 50 basis-point hike in the upcoming meetings," C6 Bank wrote in a note to clients.

In its inflation estimates, the central bank used an exchange rate of 5.60 reais per U.S. dollar, compared with a rate hovering around 5.41 early on Thursday. (Reporting by Marcela Ayres; Editing by Gabriel Araujo, Tomasz Janowski, Conor Humphries and Barbara Lewis)