Assessing the impact of the drought in Brazil

Drought conditions across parts of Brazil are not yet at the stage where there is a threat of major disruptions to electricity supply, but it has already prompted electricity prices to be hiked and there may be upward pressure on food inflation if agricultural output suffers. The government may be tempted to step in with fiscal support, particularly in a bid to shield households from higher prices, but that would only add to concerns about the direction of the public finances. All of this would reinforce Copom’s hawkishness and may result in more monetary tightening than we currently expect.