Brazil Business Forecast Report Q1 2014 - New Report Available

With high frequency data increasingly showing weakness, and given that inflation is elevated and interest rates are continuing to head higher, we believe Brazil's economic recovery is likely to remain erratic in the coming quarters.

Although headline consumer price inflation is likely past its peak, hawkish central bank rhetoric and still-elevated inflation expectations inform our view for another 75 basis points (bps) of rate hikes to 9.75% this year, implying 250bps of tightening since the beginning of 2013.

While the widespread public protests that started in June have largely subsided, we believe that this marked a turning point for the Brazilian electorate. As such, we believe that public unrest could flare up again should political progress on reforms stall in the coming months.

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Major Forecast Changes

We have downgraded our 2013 real GDP growth forecast to 2.0%, from 2.6% previously, as economic activity data remain relatively weak, and rising interest rates and still-elevated inflation are likely to continue weighing on private consumption. Moreover, our Infrastructure team believes that only the necessary projects, such as stadiums, will be completed in time for the 2014 FIFA World Cup, while several projects related to the government's PAC II growth acceleration programme will continue to suffer delays.

Although headline inflation has eased somewhat in recent months, we believe that the central bank's stated commitment to reining in price pressure, combined with still-high inflation expectations, means that we now forecast another 75bps of rate hikes to 9.75% this year.

While most major Latin American currencies stabilised in August, the real took another sharp leg lower alongside currencies such as the Indian rupee, Turkish lira and Indonesian rupiah. Given our view that poor balance of payments dynamics, as well as negative investor sentiment, will drive further depreciation in the coming quarters, we have revised our exchange rate outlook for Brazil to reflect greater weakness. As such, we now forecast the real to average BRL2.1600/ US$ in 2013 (from BRL2.1450/US$ previously) and BRL2.3000/US$ in 2014 (from BRL2.2000/US$).

Key Risks To Outlook

Upside Risks To Growth Forecast: Following a robust 3.3% yearon- year (y-o-y) real GDP growth print for Q213 and relatively strong economic activity and retail sales data being released in recent weeks, we acknowledge upside risks to our below-consensus 2.0% real GDP growth forecast for 2013.

Downside Risks To Exchange Rate Forecast: Should the real take another leg lower in the coming months as the US Federal Reserve moves closer to tapering its asset purchasing programme, we could see the unit depreciate more aggressively than we currently expect, posing downside risks to our average and end-year exchange rate forecasts for 2013 and 2014.

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