The economy grew at an annualized rate of 5.1% in 2Q10. Although GDP decelerated significantly from the unsustainable 11.3% rate posted in 1Q10, growth was faster than expected and prompted us to raise our 2010 GDP forecast to 7.6% from 7.2%. Our forecast assumes growth will further decelerate in 3Q10 due to inventory accumulation and a somewhat smaller fiscal stimulus. Even if there is no additional QoQ growth in 3Q10 and 4Q10 - which is highly unlikely given the economic fundamentals - GDP should still grow 7.0% this year due to
the statistical carryover effect.

A 2.1% QoQ increase in public consumption was one of the reasons for faster than-expected growth in 2Q10. Fiscal policy remains expansionary and we believe the government will not be able to meet its fiscal target this year without resorting to the PAC deductions. Moreover, we have not yet seen any strong indication that the government is planning to significantly tighten fiscal policy in 2011. The government reduced next year's consolidated primary surplus target slightly to 3.2% from 3.3% of GDP.

Although the economy has continued to grow above its potential, we do not expect further monetary tightening this year. Consumer price inflation of almost zero in June, July, and August due to food price deflation, and increased uncertainty about the global economic outlook, prompted the Central Bank to interrupt the tightening cycle in September. Moreover, authorities warned that a likely pick-up in inflation in coming months would not be enough for them to resume the tightening cycle, as they believe current interest rates are compatible with sustainable economic growth. Thus, the SELIC overnight rate will likely stay at 10.75% for a long time.

Despite a somewhat better-than-expected trade surplus, the current account deficit continues to increase, reflecting Brazil's need to import external savings to finance growth. However, foreign capital - especially portfolio investment - continues to pour in, attracted to the positive economic outlook and high interest rates, and will most likely be able to finance the balance of payments in 2010 and 2011. Given the resilience of foreign capital flows and the government's decision to go ahead with the capitalization of its oil company, we revised our year-end exchange rate forecast to BRL1.70/USD from BRL1.80/USD.

Eoin Treacy's view The Bovespa Index has been ranging below 70,000 since late December and while it fell below the 200-day MA in May, it has sustained a progression of higher reaction lows since. The pattern is now looking less like a top formation and a sustained move below 64,000 would be required to question scope for a further test of overhead trading.

The US Dollar is currently testing the late 2009 lows near $1.70 against the Real and a clear upward dynamic sustained for more than a day or two would be needed to question potential for a downward break.