Can Brazil balance politics and inflation?

Brazil’s 2026 election may be a breaking point for the country’s markets and policies. Fiscal rules, interest rates, and asset returns all depend on who wins. Despite potential health problems, President Lula has hinted in July at the possibility of seeking a fourth term. Meanwhile, conservative figures such as Tarcísio de Freitas and Michelle Bolsonaro are emerging as clearer potential contenders.

At 79, Lula’s advanced age and past health problems put the potential of another run at the presidency in doubt. However, his party, ‘Partido dos Trabalhadores’, currently has few strong alternatives who could successfully take on the conservatives. This means Lula is increasingly likely to run again. But even then, victory is not guaranteed. His popularity faced a major slump in early 2025, driven by high food prices and the PIX tax controversy. He managed to largely recover by mid-year after US tariff threats, widely seen as politically motivated, sparked a nationalist backlash. Lula’s response reinforced his image as a defender of sovereignty. At the same time, food inflation began to ease, allowing him to consolidate his gains in popularity by late August. Economic growth, while modest, is forecasted to reach 2.2%, large enough to prevent it from becoming a drag on Lula’s support.

This means Lula continues to be a viable contender. The labour market remains resilient, supported by rising wages and steady employment. Meanwhile, agriculture continues to perform solidly amid favourable weather and commodity prices, lending stability to rural incomes and exports. This is clearly reflected in key swing states like Minas Gerais, where Lula retains notable support. Presidential approval also tends to rise about six months before elections, as incumbents roll out generous fiscal measures to win support. In Brazil's unequal society, these tactics tend to be effective. Recent increases in public‑sector wages and social transfers continue to lift sentiment among voters.

Lula is likely to push for more generous fiscal programmes, but this may prove difficult. Around 92% of Brazil’s federal budget is locked into mandatory expenses like pensions, public salaries, health, education minimums, and debt payments. That leaves just 8% for discretionary spending, limiting the space for any large-scale election-year giveaways.

The ‘teto de gastos’, or spending cap, adds another layer to Lula’s fiscal constraints. Introduced in 2016 to rein in debt and inflation after Brazil’s economic crisis, the rule limits federal spending growth to the previous year’s inflation. Lula already loosened it with a new fiscal framework in 2023, but further changes could shake investor confidence, fuel inflation, and raise borrowing costs. For now, it seems unlikely he will risk tampering with it again.

Still, there are workarounds. In 2022, Bolsonaro lowered fuel taxes and capped prices to boost voter support. If direct government spending is constrained, Lula could turn to state-owned enterprises or banks to channel funds off-budget. Large state-owned companies like Petrobras and Eletrobras could be instructed to invest more in infrastructure, social programmes, or subsidies. State-owned banks such as BNDES, Caixa Econômica Federal, or Banco do Brasil might be encouraged to offer cheaper loans for housing, farming, or business expansion. This is exactly what happened in August 2025, when BNDES and state banks launched a 30 billion reais ‘Sovereign Brazil’ credit package to support companies hit by steep US tariffs. Earlier, in April 2025, new rules allowed 2 billion reais in payroll-deductible loans for private-sector workers at much lower interest rates (1.5–3% monthly) compared with the typical 5.9%. More than 1.2 million loans were issued by Banco do Brasil and Caixa Econômica Federal.

Such actions may help boost Lula’s popularity in the short term, but they do little to contain inflation. Mid-2025 data show inflation around 5.2%. These numbers far exceed the central bank’s official 3% target and tolerance band ceiling of 4.5%.

To fight inflation, Brazil’s central bank has continued to raise the Selic rate, its key interest rate used to steer borrowing costs. It now stands at 15%, its highest level since 2006. Even though some analysts warn even that may not be enough to effectively combat inflation, policymakers have signaled that this level will be maintained in the near term, with markets forecasting gradual reductions. It highlights the core conflict of Brazil’s economy: the central bank’s efforts to curb inflation consistently clash with pre-election fiscal expansion.

On the conservative side, much is at stake for Jair Bolsonaro. The former president is not only entangled in legal proceedings but also under investigation after police alleged he planned to flee to Argentina. A verdict is expected by early September, making it increasingly unlikely he will be able to mount a presidential bid. Still, Bolsonaro has not entirely abandoned hopes of a Trump-style comeback. If conservatives secure greater influence in the Senate, he may seek a court reversal to regain political rights. In the meantime, he is weighing potential substitutes. His wife, Michelle, remains a figure with strong national name recognition and could be pressed to step forward. Yet Bolsonaro has long favoured his son Eduardo, though his residence in the United States and limited domestic political grounding weaken the case. The most credible conservative alternative remains Tarcísio de Freitas, the governor of São Paulo and a close Bolsonaro ally. Tarcísio’s strong popularity in Brazil’s wealthiest state is undisputed, but whether he can convert this into broad national appeal remains uncertain.

Bolsonaro’s past presidency was highly polarising. Even so, after what may be a pre-election surge in public spending, investors could still welcome the return of a conservative administration with a commitment to fiscal discipline. A centre-right or right-wing government would likely prioritise cutting expenditures, stabilising public debt, and promoting private-sector growth. The transition, however, could be turbulent. Memories of unrest linked to Bolsonaro’s first term linger, and any tightening of social policies or cuts to welfare programmes could meet resistance, particularly if Lula’s base perceives the outcome as illegitimate or socially harmful.

Whoever wins the election, Brazil is unlikely to abandon its careful balancing act in foreign relations. The country will continue to cultivate pragmatic ties with its neighbours. However, relations with Washington have grown more complicated: in July, Donald Trump announced sweeping tariff measures, including a 50% levy on Brazilian exports. Lula has seized on these threats to fuel nationalist rhetoric and bolster his re-election pitch. Trade frictions are therefore set to remain a central issue.

Beyond tariffs, the broader global environment is also a risk factor. A potential U.S. recession, particularly under a volatile Trump presidency, could still trigger capital flight from emerging markets. Brazil’s central bank has reserves to defend the real, but its capacity is not unlimited. Still, compared to many of its peers, Brazil enters this period with stronger buffers and more robust macroeconomic management.

In the end, Brazil’s economic trajectory in 2025 and beyond will hinge on who governs and how they govern. Persistent inflationary pressures will demand policy discipline, regardless of ideology. Whether under Lula or a conservative rival, the next administration will have to balance fiscal ambition with economic reality. Pre-election spending manoeuvres may deliver short-term political gains, but they also risk undermining monetary policy credibility and investor confidence at a moment when stability is most needed.

Summary Q&A:

1. Why is Brazil’s 2026 election important for the economy?
Brazil’s 2026 election will decide the country’s fiscal direction and investor confidence. The outcome could affect the teto de gastos (spending cap), government spending, and inflation expectations. With interest rates at 15% (the highest since 2006) markets see the vote as crucial for stability.

2. How does inflation affect Brazil’s politics?
High inflation, especially rising food prices, reduces public support for incumbents like President Lula. In 2025, food inflation pushed approval ratings down, while later easing helped him recover. Inflation above the 3% target forces the Central Bank to keep rates high, creating tension with election-year spending.

3. What role does the Central Bank of Brazil play in inflation control?
The Central Bank of Brazil sets the Selic rate to manage inflation. With mid-2025 inflation around 5.2%, the Selic is held at 15%. Independence under Governor Gabriel Galípolo is key, but election spending through state-owned banks challenges its ability to stabilise prices.

4. Who are the main candidates for Brazil’s 2026 election?
President Luiz Inácio Lula da Silva, 79, has hinted at running again despite health concerns, as his Workers’ Party lacks a strong successor. Conservative contenders include São Paulo governor Tarcísio de Freitas and Michelle Bolsonaro. Jair Bolsonaro is barred from running until 2030.

5. How could the election outcome impact Brazilian markets?
A Lula victory may bring continued social spending, possibly using state-owned banks like BNDES or Caixa Econômica Federal. A conservative win could mean tighter fiscal discipline and pro-market reforms. Either outcome carries risks: Lula with higher inflation, conservatives with potential social unrest.