GDP slows with high interest rates and fiscal risk; tariff hikes will “help” in the coming months

After a first quarter of very robust GDP growth , the Brazilian economy is showing clear signs of slowing. The growth rate, which buoyed the market at the beginning of the year, is now slowing, a direct reflection of the prolonged impact of high interest rates and an increasingly complex international scenario, especially after the United States imposed a "tariff hike" on Brazilian imports in July.

The data that will be released this Tuesday (2) by IBGE should confirm this trend, with a modest expansion of GDP in the second quarter, estimated by financial institutions between 0.2% and 0.5%, compared to the first.

The slowdown is widespread: industry shrinks, investment is losing steam, and even the service sector, the main driver of activity, is showing signs of fatigue. Add to this the external pressure, manifested in the American "tariff hike," which is fueling global inflation and limiting the Central Bank's (BC) room for maneuver to reduce the Selic rate, currently at 15% per year. The scenario demands patience with more modest growth and increased attention to the fiscal risks accumulating on the horizon.

The handbrake on GDP: sectors lose traction

The economy's loss of traction is visible in virtually every major sector. Household consumption, although sustained by a buoyant labor market—with unemployment at a historic low of 5.8% and rising wages, according to the IBGE—is no longer growing at the same pace. Restrictive monetary policy primarily affects the purchase of credit-dependent goods, such as appliances and vehicles.

Investments are even more cautious. After growing 9.1% in the first quarter, they are expected to experience a sharp slowdown. This trend is expected to cause the investment rate to fall from 19.3% to 18.7% of GDP, according to the GDP Monitor, a monthly preview of economic activity calculated by the Brazilian Institute of Economics of the Getulio Vargas Foundation (FGV Ibre).

The manufacturing industry, in turn, remains the weak link, recording its second consecutive quarter of decline, with a 0.6% year-over-year decline, according to Itaú projections. In contrast, the extractive industry, driven by oil, is expected to have grown 4.3% in the quarter, according to XP Investimentos.

The services sector, responsible for over 70% of GDP, is still expected to grow, but with signs of fatigue. Finally, agriculture, a major player at the beginning of the year, is returning to a more normalized contribution, although it still registers robust growth of 9.8% year-over-year, according to Itaú calculations.

Juliana Trece, coordinator of the GDP Monitor research at FGV Ibre, emphasizes that the slowdown in growth is due to the lack of a strong positive contribution from agriculture and the lagged effect of high interest rates on economic activity.

The American Dilemma and the Ripple Effect in Brazil

While the domestic economy settles, the external scenario adds an extra layer of complexity. In the United States, the Federal Reserve (the American central bank) faces a classic dilemma: the labor market shows signs of weakening, while inflation remains persistent. To make matters worse, producer inflation soared to 0.9% in July 2025, much higher than expected, partly influenced by the import tariffs adopted by President Donald Trump since taking office in late January.

With the core PCE—the Fed's preferred inflation measure, which measures changes in personal consumption expenditures—projected at a high 0.4% monthly, the U.S. central bank is expected to adopt a much more cautious rate-cutting cycle than the market would like. The first cut, of 0.25 percentage points, could happen as early as September.

For Brazil, the implications are direct. Higher interest rates in the US for longer periods mean less room for the Central Bank to aggressively cut the Selic rate. The American "tariff hike," therefore, is not only a trade problem, but a global inflationary factor that forces other central banks to adopt a tougher stance.

The Brazilian crossroads: high interest rates and the specter of the fiscal deficit

Given this situation, the Monetary Policy Committee (Copom) is left with its hands tied. Even with domestic inflation showing signs of cooling, the external environment demands caution, and Copom is expected to maintain the Selic rate at 15% in upcoming meetings. Discussion of an interest rate cut in Brazil is expected to gain momentum only in the last quarter of 2025.

To make matters worse, Brazil faces a growing domestic challenge: the "fiscal specter." Projections for the 2026 Annual Budget Bill (PLOA) already indicate a primary deficit of R$30.9 billion, frustrating expectations of a balanced result next year. One factor is that 2026 is an election year.

Even with the increase in the tax burden, Banco Inter estimates that the deficit could approach 0.7% of GDP in 2026. The institution's chief economist, Rafaela Vitória, warns that, given an inflation expectation of 3.6% for 2027, "there will still be a long period of caution in monetary policy."

The combination of low growth, prolonged high interest rates, and persistent fiscal deficits is putting pressure on the public debt trajectory. With public finances in a fragile state, the government loses the ability to use the budget to stimulate the economy.

The Brazilian economy is at a crossroads: dependent on a monetary policy that cannot be relaxed and without the support of an expansionary fiscal policy.