Brazil's economy rebounds in early 2026, clouding rate cut outlook

* Household consumption, investment drive first-quarter rebound

* Economists warn stimulus may delay interest rate cuts

* Finance Ministry expects growth to slow as stimulus fades

* Government maintains 2026 forecast for 2.3% expansion (Recasts with comments from economists and Finance Ministry's secretariat)

By Marcela Ayres

BRASILIA, May 29 (Reuters) - Brazil's economy rebounded in the first three months of 2026, supported by household consumption and stronger investment, against a backdrop of a tight labour market and government stimulus that has clouded the outlook for interest rate cuts.

Latin America's largest economy expanded 1.1% from the prior quarter, government statistics agency IBGE said on Friday, slightly above the 1.0% growth expected in a Reuters poll.

That reflects an acceleration from a weak second half of 2025, when growth was just 0.3% in the fourth quarter and 0.1% in the third, according to revised IBGE data.

Household consumption - the main driver of demand - rose 1.0%, supported by government measures to expand disposable income, including an expansion of income tax exemptions for middle-income earners and real increases in the minimum wage, which boosted a range of social benefits and pension payments.

Gross fixed capital formation, a measure of investment, rose 3.5%, while government consumption edged up 0.4%.

HIGHER RATES, FOR LONGER?

Banco BV chief economist Roberto Padovani said data points to growth of about 2% this year, highlighting the economy's resilience amid global shocks. But there are questions about the sustainability of the current momentum, he added.

"One of the drivers behind this rebound is fiscal and quasi-fiscal stimulus, which runs counter to the central bank's mandate, suggesting interest rates may need to remain higher for longer," Padovani said.

As he gears up for an October re-election bid, leftist President Luiz Inacio Lula da Silva has rolled out more measures to support consumption, including subsidized credit for vehicles and a debt-renegotiation program backed by federal guarantees.

The central bank has cut rates by 25 basis points at each of its last two meetings, bringing the benchmark Selic to 14.5%. Rates remain firmly in restrictive territory given annual inflation of 4.64% and a 3% target, and economists have steadily scaled back expectations for further easing as the inflationary impact of the Iran war becomes apparent.

FORECAST REVISED

Capital Economics senior emerging markets economist Liam Peach now expects the central bank to hold rates at its next meeting in June, instead of delivering another 25 basis-point cut, as previously anticipated.

"(The first-quarter performance) comes alongside a further increase in inflation and a continued strong labour market at the start of the year, and is likely to add to caution at the central bank," he said in a note.

The Finance Ministry's economic policy secretariat said it expects a slowdown ahead, with "the fading impact of public policy measures partially offset by lower borrowing costs."

The government said it expects the economy to grow 2.3% this year, matching last year's expansion.

On the supply side, agriculture posted strong growth in the first quarter of the year, with output rising 2.0% on a strong soybean harvest. Industry expanded 1.0%, led by the extractive sector, while services rose 0.5%.

On an annual basis, gross domestic product grew 1.8%, in line with market expectations. (Reporting by Marcela Ayres; Editing by Gabriel Araujo, Brad Haynes and Chiara Rodriquez)