The result snapped a three-year run of nonstop growth for Brazil, which until recently appeared to be sidestepping the brunt of the crisis and was one of the few remaining engines of global growth as major economies in Europe, the United States and Asia sputtered.
The weak numbers, which were released on the same day that the International Monetary Fund warned that the world economy was headed for a "Great Recession," also bolstered the view that Brazil's central bank will need to aggressively cut interest rates to prevent an ever steeper downturn.
On an annual basis, gross domestic product expanded 1.3 percent in the fourth quarter from a year earlier, slowing sharply from a growth rate of 6.8 percent in the third quarter, the government's statistics agency IBGE said.
More recent data have showed that Brazil's economy started 2009 on an even weaker footing, prompting some analysts to predict that the South American giant could end up this year with zero growth.
"The fact the economy slowed so sharply in the fourth quarter sets the stage for an even steeper slowdown in 2009," said Roberto Padovani, chief economist at WestLB do Brasil in Sao Paulo.
Industrial output posted its worst-ever yearly plunge in January, sinking 17.2 percent, the IBGE said Friday. Consumer confidence remains on shaky ground, and companies like aircraft manufacturer Embraer are laying off thousands of workers to cope with plummeting demand.
The downturn has helped ease inflation as retailers slash prices to attract customers, potentially paving the way for a string of interest-rate cuts in the coming months.
Interest-rate futures at the BM&F Commodities and Futures Exchange in Sao Paulo fell sharply after the GDP numbers were released as investors priced in the chances of steeper rate cuts in the months ahead.
Brazil's central bank is expected to slash its benchmark lending rate on Wednesday by at least 100 basis points, a Reuters poll showed last week. But following the release of more weak indicators in the last few days, many economists are now betting on a more aggressive rate cut.
"We thought that inflation pressures might return at the end of the year, but now that doesn't look likely. I now see a cut of 150 basis points," said Joel Bogdanski, an economist at Banco Itau, Brazil's largest bank.
The stock and currency markets shook off the grim data, whichshowed the largest quarterly contraction since 1996. The Bovespa index jumped more than 4 percent in tandem with Wall Street and Brazil's currency, the real, gained more than 1 percent.
Manufacturing Slumps
For the whole of 2008, the economy grew 5.1 percent after expanding 5.7 percent in 2007. That was in line with market expectations of 5.2 percent annual growth, according to the median estimate of 20 economists surveyed by Reuters. Growth forecasts ranged from 3.5 percent to 5.6 percent.
GDP had been expected to shrink 2.3 percent in the fourth quarter from the third, according to the median estimate of 17 economists in the poll. Estimates for the contraction ranged from 3.4 percent to 1.5 percent.
On an annual basis, GDP had been expected to grow 1.8 percent in the fourth quarter, according to the median estimate of 22 economists. Forecasts ranged from growth of 0.6 percent to 3.1 percent.
The manufacturing sector dragged the economy down in the fourth quarter, with industries like steel producers and automakers all scaling back production as demand dried up. Industrial output slumped 7.4 percent from the third quarter, its biggest drop since the fourth quarter of 1996.
Capital spending plummeted 9.8 percent in the fourth quarter after surging 6.7 percent in the previous quarter, signaling that companies are wary of investing to increase capacity in the face of so much economic uncertainty.
The agricultural sector, a linchpin of the Brazilian economy, contracted 0.5 percent in the fourth quarter from the third, when it grew 1.5 percent.
Household consumption, which had been driving Brazil's economic boom in recent years, shrank 2 percent on a quarter-on-quarter basis.
The services sector contracted 0.4 percent from the third quarter, when it expanded 1.4 percent.
