Forecasts for inflation in Brazil are declining more than two years after policy makers

Forecasts for inflation in Brazil are declining more than two years after policy makers said they are prepared to increase borrowing costs to curb consumer prices, show bond yields.

The yield gap between inflation-indexed bonds and fixed-rate government maturing in 2013 fell 25 basis points, or 0.25 percentage point, to 612 yesterday after the central bank said there was a need " adjustment "in interest rates to curb consumer price increases. The difference in yield, an indicator of investor sentiment about inflation annually over the next two years, got to 637 earlier this week, the highest since December 2008.

The demand for inflation protection is decreasing in Brazil speculation linking the countries of Chile to Thailand in increasing borrowing costs. Brazilian bonds linked to an index of consumer prices exceeded the fixed nominal bonds in each of the past four months amid political leaders concerned for not acting quickly enough to contain inflation that accelerated to a high of 23 months.

"With rate increases, inflation expectations should fall next year," said Marcelo Schmitt, manager of fixed income portfolio Sul America Investimentos, which has 18 billion reais (10.6 million euros) under management. The excess return of inflation-indexed bonds can "come to an end," he said in a telephone interview in Sao Paulo.

Schmitt said he has been selling inflation-linked bonds and the purchase of fixed rate debt in the last two weeks.

The performance of inflation-linked notes rose 18 basis points yesterday, the most since Nov. 29 to 6.33 percent. Government debt fixed rate rose, pushing up prices and pushing yields up 7 basis points to 12.45 percent.

"Mismatch"

Annual inflation accelerated to 5.79 percent in the 12 months through mid-December, driven by food prices, credit and wage growth. It was the fourth consecutive month consumer prices exceeded the government target of 4.5 percent, plus or minus two percentage points.

Policy makers need to "contain the mismatch between the rate of expansion of domestic demand and production capacity of the economy," the report said the central bank's quarterly inflation released yesterday.

increases in interest rates 150 basis points, up 12.25 percent and a stable currency would bring down inflation to around 4.5 per cent target over the next two years, Charles Hamilton, director of the bank central to economic policy, told reporters in Brasilia yesterday. The real has risen 40 percent against the dollar in the last two years.

'Strong signal'

The inflation report sent "a very strong signal" that the central bank will "start the cycle of increases in January," said Marcelo Salomon, chief economist for Brazil at Barclays Plc in New York, in a telephone interview. The risk of inflation overshooting the upper limit of the central bank's target has decreased, while regulators sent a "clear message" that will act quickly, he said.

Barclays moved yesterday its forecast for a rate increase from January to March, predicting that the central bank will raise borrowing costs 150 basis points in late April.

Tombini Alexandre, who was confirmed as central bank president by the Senate last week, will increase lending rates by 50 basis points when he chairs his first policy meeting on 18 to 19. and push it up to about 12.5 percent by the end of 2011, interest rate futures contracts "program. Brazil's 10.75 percent rate compares with borrowing costs U.S. between zero and 0.25 percent.

The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. Treasuries fell 1 basis point to 180 at 6:21 am New York time, according to JPMorgan Chase & Co.

Default Swaps

The cost of protecting debt of Brazil against nonpayment for five years with credit-default swaps fell 1 basis point to 113, according to data compiled by CMA. Swaps credit-default pay the buyer face value in exchange for the underlying securities or the cash equivalent of a government or a company fail to adhere to its debt agreements.

The real rose 0.2 percent to 1.6972 per dollar.

Brazil's inflation-indexed bonds maturing in less than five years returned 12.7 percent this year, compared with an increase of 11.2 nominal fixed-income securities, according to data compiled by the association of capital markets.

Debt on consumer prices in the U.S. gained 8.1 percent this year, while similar values in Turkey returned 24 percent, Bank of America Merrill Lynch data show.

bonds indexed to inflation in Brazil "may lose some of the appeal had so far," Salomon said Barclays.