* Economy grows 0.4 pct in 2nd quarter, below forecast
* Shrinking investment casts doubt on expected recovery
* Farms did well, but exports and consumer activity weak
By Brian Winter and Silvio Cascione
SAO PAULO, Aug 31 Brazil's economy disappointed again in the second quarter in the latest sign of weakness among big emerging markets, and an abrupt decline in investment cast doubt on whether activity will pick up later this year as officials confidently predict.
The country's economy, world's sixth biggest, grew just 0.4 percent from the first quarter, according to data released on Friday by government statistics agency IBGE. Analysts in a Reuters poll expected a 0.5 percent expansion.
Brazil was until recently a byword for economic dynamism, mentioned in the same breath as China and India as engines for growth in a troubled world. But Brazil's $2.5 trillion economy has now been stagnant for more than a year -- dragged down by uncompetitive industries, soaring business costs and a sour investment climate caused in part by the crisis in Europe.
President Dilma Rousseff has launched more than a dozen tax cuts and other stimulus measures over the past year. Officials were quick to describe the data as an improvement over growth revised downward to 0.1 percent in the first quarter, and pointed to other evidence that the economy started to kick into a higher gear around June.
Nonetheless, Friday's data revealed several worrying trends that will limit growth in months to come. Spending on capital goods -- a key measure of business confidence -- shrank 0.7 percent from the first quarter and 3.7 percent from a year earlier. Investment is now equal to just 17.9 percent of gross domestic product -- the lowest ratio among major Latin American economies, according to Goldman Sachs.
That dubious distinction, plus recent weakness in China -- a key market for Brazil's commodities such as soy and iron ore -- mean that Brazil may struggle to reach the market's average expectations for 1.7 percent GDP growth for 2012.
"The recovery of the economy is a mirage. The mirage is going to become reality, but it's still in the realm of wishful thinking," said Julio Gomes, a consultant for the Brazilian Institute for Industrial Development.
Brazilian financial markets largely shrugged off the data, focusing instead on signs of more monetary easing by the U.S. Federal Reserve.
Brazilian industry shrank 2.5 percent in the second quarter from the first quarter, continuing a years-long slump. Even household consumption -- which had defied gravity somewhat, as consumers remained cheery about Brazil's prospects -- expanded a meager 0.6 percent.
Among reasons for hope: The central bank has cut its main lending rate five percentage points over the past year, which should help boost consumption in coming months. Finance Minister Guido Mantega also told reporters that investment should begin reacting to recent stimulus, while he expected industry to pick up thanks to recent incentives for the automotive, construction and home appliances.
"I can guarantee that the economy is now in a gradual acceleration. It's not anything spectacular, but the gradual acceleration is happening," Mantega said.
CALL FOR BIGGER REFORMS
Despite its struggles, Brazil's economy still has a lot going for it, especially compared to the United States and Europe. Unemployment remains near record lows of about 6 percent, while government finances are in good order. More than 30 million people have moved into the middle class over the past decade.
Still, many business leaders say the government's efforts won't be enough to restore Brazil to its previous glory and growth, which peaked at 7.5 percent in 2010.
They blame the slowdown on severe structural bottlenecks such as poor infrastructure and an excessive reliance on consumer debt as an engine for growth. Until Rousseff undertakes stronger efforts to stimulate investment and reduce taxes, growth may be trapped around the 3 percent range in coming years, some say.
Raymond James said Friday's data showed the economy was "changing gears from park to neutral" and cut its full-year growth forecast for 2012 to 1.5 percent from 1.9 percent.
Rousseff, a left-leaning trained economist, has in recent weeks shown greater flexibility in efforts to revive the economy. This month she announced plans to involve the private sector in more construction of highways and railroads -- a move hailed by many business leaders as a sign she will embrace more market-based remedies to boost future investment.
Rousseff is also expected to announce plans to cut electricity taxes and fees -- which should help bring down Brazil's power costs, currently the world's third highest.
Brazil's economy grew 0.5 percent in the second quarter from the year-earlier period, IBGE said. That was below expectations of 0.7 percent growth, according to the poll.
The agricultural sector grew a robust 4.9 percent from the previous quarter, thanks largely to better weather conditions and a strong harvest. That trend is expected to continue into next year, as Brazilian farmers reap the benefits of record prices for soybeans, corn and beef at a time when its main competitor -- the United States -- is experiencing a crushing drought.
The IBGE also revised downward growth data from earlier this year. It said the economy grew only 0.1 percent in the first quarter from the fourth quarter -- compared with a previously reported 0.2 percent.