* Economic activity fell 0.26 percent in June from May
* Downward revision in May adds to signs of slowdown
* Yields on rate futures decline after the report (Recasts that slowdown may be more than hoped for, adds forecasts, graphics)
SAO PAULO, Aug 17 (Reuters) - Brazil’s economic activity fell in June for the first time since 2008, adding to worries Latin America’s biggest economy could slow more than was hoped for.
The central bank's IBC-Br economic activity index BRIBC=ECI fell 0.26 percent in June from May, the first sequential drop since December 2008, when the global financial crisis plunged major economies into recession.
Economists have been revising down their forecasts for Brazilian economic growth this year amid both a weaker global economy and a slew of local factors, such as stubbornly high inflation rates.
In a report dated Wednesday, Morgan Stanley not only lowered its view for growth in the developed world this year, but also cut its Brazil GDP forecast to 3.7 percent from a previous 4 percent this year.
For next year, the cut was steeper: to 3.5 percent from 4.6 percent.
Brazil’s economy is showing strain after a 7.5 percent surge last year, its biggest jump in 24 years.
Graphic on interest rates: r.reuters.com/gun72s
Graphic on economic growth: r.reuters.com/tux38r
But that growth also came with rising consumer prices -- the fastest year-end inflation in six years. The benchmark IPCA has advanced even more since then, above a 6.5 percent government ceiling since April.
The central bank has now raised interest rates five times -- in every single meeting under bank President Alexandre Tombini, who took office in January -- to lift them to 12.5 percent from 10.75 percent this year. But price increases remain sticky, boosted in part by rising salaries amid a tight labor market.
Policymakers face a difficult trade-off: Higher interest rates might rein in those worrisome inflation rates but could also slow economic growth. But not braking inflation would also eat into real gains.
And the lower-income voters who helped propel Dilma Rousseff into the country’s presidency last year are keeping a close eye on inflation, interest rates and what economic gains they can expect in her fledgling administration.
Sagging industrial output and retail sales data in recent weeks have fanned worries the economy might be losing steam faster than initially expected.
“The bottom line is that the economy likely slowed much more than we anticipated in the second quarter,” Goldman Sachs economist Paulo Leme told clients in a note. “The initial conditions for activity are worse even before we consider the risk of contraction shocks coming from abroad.”
The bank also revised down growth in May from April to 0.05 percent from a previously reported 0.17 percent.
According to Barclays Capital economist Marcelo Salomon, the central bank’s revisions shaved nearly one-third of a percentage point off growth in the January-May 2011 period.
Leme said the data, coupled with concerns about a global economic slowdown, increased odds the central bank would hold its benchmark lending rate on Aug. 31 rather than raise interest rates as Goldman Sachs previously forecast.
The central bank has raised interest rates five times this year to 12.5 percent to try to rein inflation as it rose to its fastest pace in six years.
Yields on Brazilian interest rate futures contracts <0#DIJ:> sank in Wednesday trade on concerns activity could be slowing at a faster pace than expected. Investors usually push rates lower when they expect economic activity to slow.
The yield on the rate contract due January 2013 DIJF3, among the most highly traded early in the session, slumped to 11.75 percent from 11.86 percent in the previous session. (Additional reporting by Brian Winter and Luciana Lopez; Editing by Gary Hill)
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