(Updates prices to close, adds Bovespa afternoon move)
By Asher Levine and Walter Brandimarte
SAO PAULO/RIO DE JANEIRO, Oct 27 (Reuters) - Brazilian financial markets fell on Monday as leftist President Dilma Rousseff’s re-election victory dashed investor hopes of significant policy changes over the next four years.
Brazil’s real closed at a 9-1/2-year low. Local stocks pared losses after a sharp opening drop, though shares of heavyweight state-run oil firm Petrobras posted their biggest one-day decline in nearly six years.
The outlook for Brazilian assets will now likely depend on whether Rousseff signals policy tweaks to boost a flagging economy, as hinted in a conciliatory first speech she gave after defeating pro-business challenger Aecio Neves on Sunday.
After the most divisive and tightest campaign since Brazil returned to democracy three decades ago, Rousseff won 51.6 percent of votes in a runoff against Neves, who won 48.4 percent support.
“While Rousseff’s victory speech carried a conciliatory tone and invitation for debate and change, her ability to regain credibility will require more than just words,” said Flavia Cattan-Naslausky, a strategist with RBS Securities.
Brazilian markets will only stabilize, she said, once Rousseff announces “concrete policy initiatives” and makes appointments to government positions such as the finance ministry and the central bank.
Most analysts remain skeptical, however, as Rousseff’s first term saw little in the way of significant economic reforms.
Those doubts were fed on Monday afternoon when outgoing Finance Minister Guido Mantega offered a rosy assessment of the Brazilian economy and said the election “shows that the population approves of the economic policy we are practicing.”
Mantega’s statements kept downward pressure on the real, which closed 2.6 percent lower at 2.5223 per U.S. dollar.
“The person who probably needs to come in is someone who is a bit more realistic about economic projections (than Mantega),” said Christopher Palmer, who helps manage about $1 billion of Latin American assets for Henderson Global Investors in London.
Most investors are betting the Brazilian currency will weaken over the next few years as U.S. Treasury yields rise and Brazil tries to boost industry competitiveness.
“Without an acceleration in productivity, a further correction of the real seems highly probable in the near future,” Santander economists led by Mauricio Molan said. They forecast the real will overshoot in the short term, later converging to 2.55 per dollar at the end of the year.
Other analysts warned, however, that under a second Rousseff term the central bank is likely to extend its intervention program to cushion any currency losses that would further fuel inflation.
Brazil’s tight and fast-changing election campaign had sent its financial markets on a wild ride with big gains whenever Rousseff lost ground in polls and drops whenever her odds looked stronger.
The Bovespa index fell as much as 6.2 percent in early trade but later trimmed losses to close with a 2.77 percent decline as bargain hunters swooped in, leaving the index at 50,503 points.
The drop was less than some investors had expected before market open. Traders said cheap valuations for Brazilian stocks in dollar terms, the need among short-sellers to cover positions, and a somewhat priced-in Rousseff victory helped keep the index from plunging further.
The index could drift towards the mid-to-high 40,000 point level in the near future, Citi analysts Stephen Graham and Fernando Siqueira wrote on Monday.
“At that point we would see limited downside and substantial theoretical upside, but the latter only if (Rousseff’s administration) takes decisive steps in new directions,” they wrote.
Rousseff’s economic policies have been roundly criticized by investors for tipping Brazil into a recession while damaging state-run companies such as oil producer Petroleo Brasileiro SA , known as Petrobras, and lender Banco do Brasil SA along the way.
Preferred shares of Petrobras fell as much as 15.6 percent at the open, easing to an 12.33 percent loss by the close. Still, it was the stock’s biggest one-day loss in nearly six years.
Petrobras’ share price has suffered under Rousseff’s government due to a policy that holds down domestic fuel prices in order to help relieve inflation.
Shares of Banco do Brasil fell 5.24 percent. The bank has seen pressure from Rousseff’s government to lower lending spreads in order to juice consumption in a sputtering economy.
Yields paid on long-dated contracts for interest-rate futures surged, with the Jan. 2023 maturity shooting 34 basis points higher. Those yields had recently fallen sharply on bets that stricter fiscal and monetary policy in a Neves’ government would make room for lower interest rates in the future.
Shorter-dated contracts saw yields fall, however, as some traders speculated that the central bank will be less aggressive in raising the benchmark Selic rate next year under Rousseff, even as inflation remains high.
Brazil’s debt insurance costs also rose in the credit default swaps (CDS) market. Data from Markit showed that five-year CDS were up 5 basis points versus Friday’s closing level to 167 bps. (Additional reporting by Paula Laier and Jeb Blount; Editing by Nick Zieminski, Gunna Dickson and Grant McCool)