New risks for inflation and economic growth?

In May, Brazilian equities were among the weakest performers in the EM universe, causing the entire Latin American region to bring up the rear, as the equity index in Sao Paolo lost roughly 3%. Looking at economic developments, the usual economic data were of secondary importance in recent weeks, as attention was concentrated on the massive flooding in the state Rio Grande do Sul. This state, the fourth largest in Brazil in terms of economic output, is faced with catastrophic damage following torrential rains. Agriculture (e.g. soy production) will suffer from an almost complete loss of harvests, and major damages are also expected in tourism, industry, and infrastructure.

As a result of this catastrophe, Brazil’s economic output may be about 0.4% lower this year. It is still hard to estimate to what extent these events will drive up inflation. The markets’ expectations for inflation declined slightly and so far all but one of the previously anticipated interest rate cuts have been priced out. In any case, Brazil’s always very tight budget situation will be exacerbated by this disaster, as resources will be needed for aid and reconstruction. Even before the floods, the budget surplus in April was only about one half as high as expected. So far, however, both the index for economic activity and industrial production are still looking positive. Although the latter was slightly disappointing in March, on the whole it reflects a strong growth trend.