Brazilian Economy Strengthens in February

The Brazilian economic activity index increased 0.2 percent month-over-month in February after an upwardly-revised print of 2.4 percent in January. Year over year, the economy grew 4.0 percent. 

Stronger Growth Even as the Central Bank Tightens Policy  

The Brazilian economy is showing signs of improvement even as the Brazilian central bank has been tightening monetary policy for a while. The latest monthly index of economic activity grew 0.2 percent month-overmonth in February. While the number was marginally lower than  expectations, at 0.3 percent, the January growth rate was upped to 2.4 percent for 1.3 percent, which makes the 0.2 percent reported for February stronger than the market’s expectation. Furthermore, the yearover-year rate of growth strengthened to 4.0 percent from a print of only 0.9 percent for the twelve months ending in January. Although Brazilian economic numbers have been all over the growth spectrum during recent months, they are firmer overall and seem to support the case for growth strengthening during the rest of the year. Inflation readings have been stronger, and the central bank has continued to tighten monetary policy. 

Having said this, the effects of central bank tightening are not fully felt, so growth may not strengthen too much during the year unless the external sector shows some recovery. So far it is the domestic market that is driving growth in the Brazilian economy and higher interest rates will put a dent on this growth going forward. Earlier this week we had the release of retail sales and there were still no indications that domestic consumption is trending downward. Retail sales were up 0.2 percent in February compared to January and by a more-than-expected 8.5 percent on a year-over-year basis after a print of 6.4 percent in January. 

Central Bank Tightening May Not be Over

Although some of the strengthening in inflation has been a consequence of the Brazilian government’s policy decision to start “rationalizing” energy prices, i.e., allowing energy prices to be determined by market forces, it is also clear that consumer demand is still relatively strong and contributing to these higher inflation readings. This means that the central bank will remain vigilant as the year progresses and may err on the side of caution as the FIFA World Cup approaches with the potential to create even more pressures on inflation. 

The biggest problem for the central bank is that wholesale prices have been going up rapidly and those prices are a precursor for higher consumer prices in the coming months. Thus, the probability for still higher interest rates has increased considerably during the last several weeks. The central bank increased interest rates from 7.25 percent in March 2013 to 11.0 percent in early April of this year while hinting at a pause in the coming months. However, today, that pause may not be as long as markets had been anticipating especially if the central bank does not see some weaker inflation numbers soon