Bloomberg — Brazil’s economy shrank more than expected in May according to the central bank’s main gauge of activity, as President Luiz Inacio Lula da Silva’s government advances key reforms and investors bet on rate cuts.
The bank’s economic activity index, a proxy for gross domestic product, fell 2% from the prior month, more than all forecasts in a Bloomberg survey that had a -0.10% median estimate. From a year ago, the gauge increased 2.15%, according to data published on Monday.
Swap rates, which indicate investor’s sentiment toward monetary policy, slumped in morning trading as traders mulled odds of an even bigger monetary easing cycle ahead.
“It’s a big negative surprise, but data has been extraordinarily volatile,” said Alberto Ramos, chief Latin America economist for Goldman Sachs & Co. At this point, a rate cut next month is a “high probability event” with questions about whether central bankers will begin with a quarter-of-a-percentage point drop or a reduction of 50 basis points, he said.
Latin America’s largest economy is cooling down as central bankers hold interest rates steady at 13.75% for close to a year following an aggressive tightening cycle. Retail sales are falling and annual inflation continues to ease further within the monetary authority’s tolerance range. On the other hand, agriculture surged at the start of 2023, providing support to growth.
Brazil isn’t the only country in the region with weakening activity. Peru and Argentina are nearing recession, while Chile’s economy has also dropped ahead of the start of an expected monetary easing cycle later this month.
Deceleration
In Brazil, economic activity in May was mixed, Gabriel Couto an economist at Banco Santander in Brazil, wrote in a research note. Though the central bank doesn’t provide a breakdown by industry, the overall drop likely reflects a return to more normal levels of grain production after stronger-than-expected output the month prior, he wrote.
High interest rates should cool down sectors that are more sensitive to monetary policy in the months to come. “We continue to see signs of deceleration for broader activity ahead,” Couto wrote.
Central bankers led by Roberto Campos Neto have said they will need “patience” and “serenity” to assess the impacts of high rates on the economy, though they left the door open for borrowing cost cuts starting next month if factors like inflation forecasts improve. Analysts’ estimates for consumer price increases stand at 4.95% for this December and 3.92% at the end of next year, according to a central bank survey published earlier Monday.
Brazil’s central bank targets inflation at 3.25% for this year and 3% between 2024 and 2026.
Lula’s government also continues to advance key reforms aimed at bolstering the economy. Congress is expected to hold a final vote on a bill to shore up public finances, while the lower house has backed a tax overhaul that had been discussed for decades.
Investors are increasingly optimistic about Brazil’s economic outlook, prompting Finance Minister Fernando Haddad’s approval levels to rise, according to a recent poll.
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