Brazil's central bank says stronger activity driving inflation estimates higher

BRASILIA (Reuters) -Brazil's central bank said on Thursday that stronger-than-expected activity is the main reason behind its higher inflation projections, one of the factors that led it to halt interest rate cuts earlier this month.

In its quarterly inflation report, the central bank bumped its 2024 economic growth forecast to 2.3% from the 1.9% predicted in March.

According to the central bank, the move followed a more robust economic performance in the first quarter, accompanied by a drop in unemployment and rising wages.

Although last month's historic floods in Brazil's southernmost state of Rio Grande do Sul have caused a significant economic downturn in the region, policymakers said signs of recovery were already visible.

In the report, they emphasized that their inflation projections - now at 4.0% for this year, 3.4% in 2025 and 3.2% in 2026, against an official target of 3% - were primarily increased due to stronger-than-expected activity, which led to a change in the estimated output gap.

The central bank indicated last week that the output gap, a measure of the supply-demand economic balance, was now "around neutrality" compared to slightly negative previously, meaning it no longer saw slack in Latin America's largest economy.

Earlier this month, the bank held interest rates at 10.50%, interrupting an easing cycle after it reduced borrowing costs by a total 325 basis points since August.

According to policymakers, higher inflation projections were also influenced by increased market inflation expectations, currency depreciation, short-term projection inertia and a higher neutral interest rate.

They had previously disclosed that the neutral interest rate, which neither stimulates nor cools economic activity, was raised to 4.75% from 4.5%.

Policymakers also noted that inflation in the three months to May was 14 basis points higher than expected, mainly due to pressure on food prices. The same factor led to a revision of their expected inflation for June to 0.33%, from 0.15% previously.

(Reporting by Marcela Ayres; Editing by Gabriel Araujo)