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Brazil markets plunge as political scandal threatens reform plans

[SAO PAULO] Brazilian markets plummeted on Thursday after allegations that President Michel Temer condoned bribes to silence a witness in a corruption probe fuelled bets he could be ousted, derailing an ongoing reform agenda.

Brazil's benchmark Bovespa stock index was down 8.4 per cent by noon local time, trimming an earlier loss of 10.7 per cent that constituted its biggest daily decline since the 2008 financial crisis.

Trading on the São Paulo Stock Exchange was temporarily halted for about an hour after the index dropped 10 per cent in morning trading, triggering a circuit-breaker mechanism. Most stocks pared losses after trading resumed.

Blue-chip stocks such as lenders Itaú Unibanco Holding SA, and state-controlled oil company Petróleo Brasileiro SA subtracted the most points from the index.

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The slump slashed 24 billion reais and 21 billion reais (S$9.4 billion and S$10.7 billion) off the market value of Itaú and Petrobras, respectively.

Mr Temer was caught on tape encouraging a prominent executive to pay a monthly fee to keep jailed former House Speaker Eduardo Cunha silent in the country's biggest-ever graft probe, sources said on Wednesday, confirming a report in newspaper O Globo. Mr Temer denied reports that he had authorised such payments.

The report threatened to torpedo a two-year rally in Brazilian assets as traders quickly reassessed the chances of success of efforts to streamline the country's social security system and reform labor regulations. As a result, policymakers attempts to curtail the growth of public debt and foster economic growth may also now be in doubt. "For the market, it's not a question of whether Mr Temer will be ousted or not. The question is whether it will be quick and for how long reforms will be delayed," trader Thiago Castellan at Renascença brokerage said.

On Thursday, Mr Temer resisted calls to resign, strongly denying the accusations.

The Brazilian real slumped 7.0 per cent, wiping out its gains for the year after reaching a two-month peak this week, while bond prices slumped. The sharp moves drove the market operator B3 to widen the limits on trading of several derivatives and put policymakers on alert.

The central bank sold US$2 billion worth of new traditional currency swaps, which function like sales of dollars to investors for future delivery. The National Treasury called off an auction of fixed-rate and floating-rate bonds scheduled for Thursday, citing sharp market volatility.

Strategists at JPMorgan Securities downgraded their recommendation on Brazilian equities to "neutral" from "overweight", citing increased risks to the implementation of structural reforms.

Yields paid on Brazilian interest rate futures spiked as traders bet the central bank would be forced to cut rates at a slower pace as the reforms outlook dimmed.

Rate futures prices indicated traders saw a 73 per cent chance that the central bank would cut the benchmark Selic rate by 75 basis points this month and a 27 per cent chance of a 50 basis-point reduction. On Wednesday, most bets pointed to a cut of 125 basis points.