|
Industry
rebounds but not yet on clear recovery track
Following
a temporary drawback in April, industrial production continued on a
recovery track. In May, industrial production increased 4.8% over the
same period last year, contrasting the 1.7% decline registered in April
and exceeding market expectations of a 3.5% expansion. Apart from healthy
expansions in February and March this year, the May reading constitutes
the strongest reading since June last year. A rebound in manufacturing
following April’s decline accounted for the lion share of the pick-up,
followed by the mining sector, which also accelerated compared to April.
Moreover, healthy capital and consumer goods production boosted the May
reading significantly. A month-on-month comparison corroborates the
strong acceleration suggested by the annual data, as industrial production
increased 1.56% in seasonally adjusted terms over the previous month.
Nevertheless, despite the solid reading, the annual average growth rate
remained at the 2.6% level observed in April. Consensus Forecast
participants expect the recovery in industrial production to persist
throughout the year, with full-year growth reaching 4.2%, which is up 0.1
percentage points from last month’s forecast. Next year, Consensus
Forecast panellists anticipate that industrial production will remain
healthy and expand 4.3%, down 0.2 percentage points from last month.
Improved external
finances prompt credit rating upgrade
The economy expanded
more than expected in the first quarter, which adds optimism to the
outlook for the full year. Strong domestic demand, which drove the
economy in the first quarter, is likely to continue as a key driver behind
economic growth. The Central Bank has consequently been easing monetary
policy since August last year, creating a more
favourable
environment for domestic demand. However, at the beginning of June, Bank
officials stated that further interest rate reductions will be made with
caution, out of concern that a decline in international demand for local
securities might weaken the currency and raise inflation. As a result of
the current healthy developments, the government projects economic growth
to reach 4.5% this year, which is almost double the pace registered last
year. Additional indicators point to continued healthy developments in
domestic demand. In April, retail sales grew at the strongest pace since
March last year, registering 7.4% annual growth (March 2006: +3.0% year-on-year).
Strong consumption is likely to continue, as President Luiz Inácio Lula da
Silva boosted minimum wages by 17% in May. Increased government spending
was the main reason why the fiscal budget in May registered the first
monthly deficit since February this year. Moreover, the primary surplus,
which works as a gauge of government’s ability to service debt and control
expenditures, reached 4.51% of GDP for the twelve months ending in May, a
slight deterioration compared to the 4.54% registered in April but above
the government’s 4.25% annual target. In addition, as a result of
continuous improvement in external finances of the public sector and
businesses, international credit agency Fitch Ratings upgraded the
country’s long-term foreign currency rating from “BB-“ to “BB” on 28 June.
The rating is still two levels below investment grade status. Moreover,
in recent consultations with the International Monetary Fund (IMF),
concluded on the 19 June, Fund officials praised recent improvements in
economic growth and inflation converging to official targets. Fund
officials also pointed out reduced vulnerability as a result of lowering
external debt, building up international reserves as well as improving the
composition of domestic debt. The IMF expects growth to reach 3.5% this
year. Consensus Forecast panellists are also optimistic about this year’s
growth and expect economic activity to accelerate throughout this year,
with full-year reaching 3.5%, which is unchanged from last month’s
Consensus Forecast figure and below the 4.5% government estimate. Next
year, the pace of economic activity should accelerate moderately with
growth reaching 3.6%.
Incumbent President
Lula to run for second term
On 24 June, President
Luiz Inacio Lula da Silva formally announced his bid to run for a second
term in the upcoming presidential elections on 1 October. Recent polls
point to a narrowing of the lead that the president has enjoyed for many
months. According to a survey conducted on 28-29 June by pollster company
Datafolha, support for Lula increased to 46% in June compared to 45% in
the May poll. However, support for the main opposition candidate Geraldo
Alckmin from the Social Democracy Party also rose from 22% in the May
survey to 29% in June, narrowing the gap to the front running president
notably. Nevertheless, despite the narrowing lead over the second
candidate, the poll showed that the president would still win presidential
elections in the first round with 54% of valid votes, compared to 35% for
Alckmin.
Consumer
prices register sharpest monthly drop in eight years
In June,
consumer prices dropped 0.21%, contrasting the 0.10% increase registered
in the previous month and undershooting market expectations of a 0.13%
decline. In fact, the June reading constitutes the strongest monthly
price decline registered since September 1998. Lower food, transport and
home equipment prices prompted the June price decline, which was partly
mitigated by higher health prices. As a result of the June price
developments, annual headline inflation plummeted from 4.2% in May to 4.0%
in June, continuing a downward trend that has been in place since May last
year with only temporary interruptions. In fact, the June inflation level
constitutes the lowest inflation level registered since June 1999.
Consequently, annual inflation remains below the 4.5% Central Bank target
for this year, but within the
±2.5% tolerance margin of the central target. In the last
monetary policy meeting held on 31 May, the Central Bank lowered the
benchmark SELIC interest rate for
the eight
consecutive month from 15.75% to 15.25%, marking a five year low. The
next monetary policy meeting will be hold on 18-19 July. Consensus
Forecast participants anticipate that consumer price pressures will
moderate further this year and expect year-end inflation to reach 4.4%,
which is down 0.1 percentage points from last month’s forecast figure.
Next year, Consensus Forecast panellists expect inflation is likely to
remain at the same 4.4% level.
Currency recovers
following May weakening
In June, the exchange
rate appreciated 6.29% in nominal terms to reach 2.16 reais to the
US. The June strengthening sharply contrasted the 9.18% depreciation
registered in May. However, the May weakening, which reflected concerns
about higher U.S. interest rates, had constituted an exception in a
virtually uninterrupted appreciation trend observed since the end of
2004. Throughout the course of the appreciating currency, the Central
Bank has continually intervened
in foreign
exchange markets to weaken the currency.
The June strengthening represents the strongest appreciation registered
since September of last year. As a result of the June developments, the
currency is now trading 8.6% stronger than in June of last year, compared
to a 3.4% year-on-year appreciation observed last month. The June
strengthening reflects the boosting effects of easing inflation and
accelerating growth in export revenue inflows. Moreover, the currency
gained ground at the end of the month as the U.S. Federal Reserve
indicated that the current monetary tightening cycle may be near an end.
President Luiz Inacio Lula da Silva has announced that, if re-elected in
October, the government will strive to weaken the currency by changing
foreign currency market rules. Consensus Forecast participants expect the
currency to depreciate 3.8% from its current level to reach 2.25 reais
to the US$ by year-end. Next year, Consensus Forecast panelists expect
the exchange rate to depreciate 4.2% to close at 2.35 reais to the
US$. |
