Strong Growth And Loose Fiscal Policy Gives The Brazil Central Bank The Green Light To Hike

• Resilient economic activity, fiscal slippage and rising inflation expectations will see the Banco Central do Brasil (BCB- Brazil Central Bank) begin a modest tightening cycle over what is left of the second half of 2024 (H2 2024).
• Growth came in well above trend at 1.4% q-o-q (3.3% y-o-y) in Q2 2024. What made this print more impressive is that it followed a strong Q1 2024 growth figure of +1.0% q-o-q and came despite severe flooding that disrupted the harvest season in the south of the country in May
• According to Fitch Solutions, the economic strength is partially a reflection of rate cuts pushed through over H2 2023 and H1 2024 and still reasonably supportive fiscal policy, which have helped to underpin domestic demand.
• In terms of fiscal policy, the Lula administration’s budget proposals for 2025 (Fiscal tightening, with the primary deficit set to narrow modestly from 0.6% of GDP in 2024 to 0.4% per Fitch’s forecasts) suggest that it will again fail to comply with the fiscal framework that was unveiled in 2023, with revenue likely to disappoint relative to plan and little effort being made to rein in spending.
• The upshot of these developments is that Fitch now believes that the BCB will perform a policy U-turn in the coming weeks, with a mini hiking cycle that Fitch suspects will begin on September 18. It is expected that the Central Bank will raise the Selic rate from 10.50% to 11.50% by year-end, reversing roughly a third of the cuts implemented over the prior year.
• Going forward, space exists for the BCB to revert to loosening mode over 2025, as tighter monetary policy works to slow domestic demand and, in turn, inflation. However, incoming President Gabriel Galípolo is likely to move cautiously to build up his credibility with investors, who are wary of his ties to Lula.

(Source: Fitch Solutions)