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Industrial production nosedives
In June, industrial
production dropped 0.6% over the same month last year, which was well
below market expectations of a 1.6% expansion. The June reading
represented a dramatic reversal from the healthy growth figure observed in
May, when industrial activity increased 4.8% year-on-year. Moreover,
industrial production does not appear to have rebounded yet, as the June
output decline represents the second drop in output this year. The
decline in industrial production was broad-based but was most pronounced
in the medical and transport equipment sectors. Furthermore, while
consumer goods output experienced meagre growth, both capital and
intermediate goods production experienced strong deterioration. A month-on-month
comparison confirms the weak June reading, as industrial production
declined 1.67% over the prior month. Furthermore, as a result of the June
figure, the annual average growth rate dropped from 2.6% in May to 2.0%,
which is the lowest rate observed since March 2004. Nevertheless,
Consensus Forecast participants expect industry to recover notably in the
second half of this year with growth reaching 4.2%, which is unchanged
from last month’s projection. Next year, the expansion in industrial
output is likely to accelerate slightly to 4.3%.
Strong consumption
likely to fuel growth
Economic activity
expanded more than expected in the first quarter on the back of strong
domestic demand. The increasingly supportive domestic economy is likely
to continue as a key driver of economic growth. Since August last year,
the Central Bank has been easing monetary policy and thereby created a
more favourable backdrop for domestic demand. In its 19 July monetary
policy meeting, the Bank cut the benchmark rate further to reach the
lowest level registered in more than twenty years. Nevertheless, in
minutes from the policy meeting released on the 27 July, Central Bank
officials reiterated previous statements that further monetary policy
easing will be made with “more parsimony” amid concerns that a pick-up in
economic growth could spark inflation. Currently, the government projects
economic growth to reach 4.5% this year, which is almost double the pace
observed last year. Additional indicators point to continued healthy
developments in domestic demand. In May, retail sales continued the
robust growth pace registered in April, expanding 7.3% year-on-year (April:
+7.5% year-on-year) and boosting the annual average growth rate from 5.0%
in April to 5.4%. The current strong consumption trend is likely to
continue, bolstered by the 17% minimum wage rise implemented in May.
Consensus Forecast panellists are also optimistic about this year’s growth
and expect economic activity to accelerate throughout this year, with
full-year reaching 3.6%, which is up 0.1 percentage points from last
month’s Consensus Forecast figure but below the 4.5% government estimate.
Next year, the pace of economic activity should accelerate slightly with
growth reaching 3.6%, which is unchanged from last month.
Public finances
strained ahead of October elections
The upcoming
presidential and parliamentary elections in October are beginning to cast
a shadow over public finances. In June, the fiscal account registered the
strongest deficit in four months in the wake of increased government
spending and rising interest payments on the country’s debt. However, 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 June, virtually unchanged from May and remaining above the
government’s 4.25% annual target. Finally, a planned 17% pension rise to
all the country’s pensioners, that would have imposed a further burden on
the country’s budget, was vetoed on 10 July by President Luiz Inacio Lula
da Silva. The veto eased some concerns that the country would fail to
meet fiscal targets this year amid increased government spending ahead of
elections. Moreover, on 24 July, Deputy Finance Minister Bernard Appy
assured that if Lula is re-elected, government spending will be cut in
order to meet fiscal targets.
Lula’s lead narrows as
presidential elections draw closer
While Lula’s fiscal
responsibility and recent veto of a pension rise sends positive signals to
the markets, opinion polls ahead of the October elections show a slightly
different reaction. Recent polls point to a narrowing of the lead that
the president has enjoyed for a long time. According to a survey
conducted from 17-18 July by pollster company Datafolha, support for Lula
dropped to 44% in July compared to 46% in the June poll. Simultaneously,
support for the main opposition candidate Geraldo Alckmin from the Social
Democracy Party (PSDB, Partido da Social Democracia Brasileira)
also decreased slightly from 29% in the June survey to 28% in July,
narrowing the gap to the front running president a further notch. In
contrast, candidate Heloísa Helena from the left-leaning Socialism and
Freedom Party (P-SOL,
Partido
Socialismo e Liberdade)
party gained significantly more support over the June survey, moving from
6% to 10% in July. A third candidate gaining ground could prevent Lula
from winning in the first round, leaving the second round decisive. A
survey conducted by pollster company Ibope from 22-24 July, however, shows
that despite loosing ground in July, the president would still win the
election in the first round.
Central
Bank cuts interest rates to 20-year low
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 most pronounced
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. July inflation data will be released
on 11 August. As a result of the favourable price developments in June,
the Central Bank lowered the benchmark SELIC interest rate for
the ninth
consecutive month from 15.25% to 14.75% on 19 July, marking a twenty-year
low. Moreover, the Bank could opt for further rate cuts in its next
monetary policy meeting on 29-30 August. Consensus Forecast participants
expect year-end inflation to reach 4.1%, which is down 0.3 percentage
points from last month’s forecast figure. Next year, inflation is likely
to accelerate slightly, as Consensus Forecast participants expect consumer
prices to rise 4.4%, which is unchanged from last month’s figure.
Central Bank loosens
currency rules
In July, the exchange
rate depreciated a modest 0.55% in nominal terms to reach 2.18 reais
to the US$. The July depreciation was in sharp contrast to the 6.29%
appreciation observed in June. The currency has appreciated virtually
uninterrupted since the end of 2004. Despite the July depreciation, the
currency is now trading 9.8% stronger than in July last year, compared to
the 8.6% year-on-year appreciation observed last month. Throughout the
course of the appreciating currency, the Central Bank has continually
intervened
in foreign
exchange markets to weaken the currency. On 26 July, Finance Minister
Guido Mantega
announced a change to the current exchange rate regime. Exporters will
now be allowed to keep 30% of their export earnings abroad. Until now,
companies have been required to repatriate dollars earned through exports
and convert them into reais no later than 210 days following export.
The measure is not intended to weaken the currency, but rather to
lessen its appreciation. Markets had expected a more significant change
to foreign exchange rules. In June, President Luiz Inacio Lula da Silva
had announced that, if re-elected in October, the government will strive
to weaken the currency by further tweaking foreign currency market rules.
Consensus Forecast participants expect the currency to depreciate again to
2.22 reais to the US$ by year-end, which is 5.6%
stronger than at the end
of 2005. Next
year, Consensus Forecast panelists expect the exchange rate to depreciate
4.4% to close at 2.32 reais to the US$.
Current
account narrows as trade balance deteriorates
In the
second quarter, the current account balance incurred a surplus of US$ 1.3
billion. The surplus was below the US$ 1.7 billion surplus registered in
the previous quarter and only half the US$ 2.6 billion surplus observed in
the same quarter last year. A narrowing in the trade surplus was the main
reason of the deterioration in the current account compared to the same
quarter last year. In the second quarter, the trade balance registered a
US$ 10.2 billion surplus, which was down from the US$ 11.4 billion surplus
registered in the same quarter of 2005. Exports decelerated markedly in
the second quarter, expanding 7.8% year-on-year, less than half the 20.2%
pace registered in the first quarter. Imports also decelerated, but
maintained a strong double-digit pace, moving from a 24.2% expansion in
the first quarter to 19.3% growth. As a result of the second quarter
reading, the annual current account surplus dropped from US$ 13.3 billion
in the first quarter to US$ 12.0 billion. Consensus Forecast panellists
anticipate exports to grow at a slower pace this year, while imports will
maintain the growth pace. As a result, the annual trade balance will drop
from US$ 44.8 billion in 2005 to US$ 40.8 billion and the current account
surplus will narrow to US$ 8.7 billion this year. |
