UPDATE 3-Brazil's economy slows sharply, avoids expected contraction

(Adds comment from finance minister in paragraphs 4-5, inflation and interest rate data in paragraph 6)

By Marcela Ayres

BRASILIA, Dec 5 (Reuters) -

Brazil's economy avoided contraction in the third quarter, extending a run of better-than-expected growth, but its sharp slowdown underscored a softer outlook for activity due to falling investment and the fading impact of a strong harvest.

Latin America's largest economy grew by a seasonally adjusted 0.1% in the three months through September, government statistics agency IBGE said on Tuesday. Economists had forecast a 0.2% drop in a Reuters poll.

Although the slowdown was not hard as expected, the gross domestic product (GDP) data reinforced the outlook for Brazil's central bank to keep cutting interest rates, as inflation cools rapidly from its 2022 peak.

"We had a positive but weak GDP," Finance Minister Fernando Haddad told journalists in Berlin, forecasting a more than 3% growth this year and about 2.5% growth next year.

"But the central bank needs to do its job," the minister added, highlighting high interest rates and falling inflation.

Brazil's central bank started cutting rates from a six-year high in August and has already reduced interest rates by 150 basis points to 12.25%. Inflation in 12 months fell to 4.84% through mid-November from a peak of 12.13% in April 2022.

IBGE revised up second-quarter growth to 1.0% from 0.9% previously, and revised down first-quarter growth to 1.4% from 1.8% previously.

In the third quarter, services activity and industrial output both expanded 0.6%, while agricultural output fell by 3.3%.

"It's hard to predict what will happen in the fourth quarter given the volatility of output in the agricultural sector," said William Jackson, chief emerging markets economist at Capital Economics. "The bigger picture is that the strong growth seen in the first half of the year has come to an end."

"We think the economy is entering a phase of softer growth – more akin to the growth rates recorded in the years before the pandemic of 1.0-1.5%."

It was the third straight quarter of economic growth, lifting gross domestic product (GDP) to its highest level ever, 7.2% above its pre-pandemic level, according to IBGE.

President Luiz Inacio Lula da Silva took measures this year to increase households' disposable income, providing a lingering boost to family spending.

Household consumption rose by 1.1% in the third quarter, while government spending grew by 0.5%. Fixed business investment fell by 2.5% from the prior quarter.

"Household consumption increased, possibly boosted by the consistently good performance of inflation, which contributes to real income and purchasing power," said Felipe Salto, chief economist at Warren Rena. He said fixed investments are still suffering from high borrowing costs.

Compared to a year earlier, the economy's 2.0% growth was slightly more than the 1.9% rise economists had expected, but well below the 3.5% recorded in the previous quarter. (Reporting by Marcela Ayres Editing by Brad Haynes and Chizu Nomiyama)