Policy makers raised their 2011 inflation forecast to 5 percent, up from 4.6 percent in September, according to the so- called reference scenario published today in the bank’s quarterly inflation report. They forecast inflation will also exceed their 4.5 percent target in 2012, when consumer prices will rise 4.8 percent. The bank’s reference scenario assumes the benchmark rate remains unchanged.

“It is important to highlight that, in an inflation targeting regime, divergence from the target of the size implied in these projections suggests the need to implement, in the short term, adjustments in the benchmark interest rate,” policy makers said. The central bank needs to “contain the mismatch between the pace of expansion of domestic demand and the production capacity of the economy.”

Traders are wagering newly appointed central bank President Alexandre Tombini will have to resume raising lending rates when he chairs his first monetary policy meeting Jan. 18-19, interest-rate futures contracts show.

Yields on contracts maturing in January 2012 rose 12 basis points to 12.12 percent at 8:49 a.m. New York time. The real weakened 0.1 percent to 1.6968 per U.S. dollar.

New Call

Banco WestLB do Brasil’s Roberto Padovani, who previously forecast interest rates would remain unchanged in 2011, changed his forecast for the Selic following the release of today’s report. He now expects policy makers to lift the overnight rate to 11.25 percent in January from 10.75 percent. By year-end, the rate will jump to 12.25 percent, he said.

“The central bank comments put an end to doubts -- it implies a rate increase in the short term, in January,” Padovani, chief economist for the WestLB, said in an interview in Sao Paulo.

Policy makers kept the benchmark interest rate unchanged at 10.75 percent for a third straight meeting on Dec. 8, saying they needed more time to gauge the impact from recent measures to slow credit growth. Earlier this year they increased the Selic rate by 200 basis points from a record low 8.75 percent.

Inflation in the 12 months through mid-December quickened to 5.79 percent, the fastest pace in 23 months, on higher food prices, the national statistics agency said yesterday. It was the fourth consecutive month consumer prices as measured by the IPCA-15 index exceeded the government’s 4.5 percent target.

The central bank will raise the overnight rate next year by at least 200 basis points to 12.75 percent in a bid to rein in inflation, according to Bloomberg estimates based on interest rate futures contracts.

‘Hawkish Bias’

Inflation, which has been stoked by food and commodity prices in recent months, is also being fueled by a mismatch between supply and demand, policy makers said today.

Today’s report “had a strong hawkish bias,” Nick Chamie, head of emerging markets at RBC Capital Markets in Toronto, wrote today in an e-mailed report.

The bank raised reserve and capital requirements on Dec. 3 to slow credit growth, saying the move would also help contain inflation. The higher reserve requirements removed 61 billion reais ($36 billion) from circulation, according to central bank estimates.

Policy makers said today their inflation forecast for next year already takes into account the impact of the moves to slow credit and “fiscal efforts” by the government. Credit expansion needs to ease to help bring inflation back to target, they said.

Carlos Hamilton, head of the bank’s economic policy department, told reporters in Brasilia today that outstanding credit will grow 15 percent next year, down from an expected 20 percent growth rate this year. Demand will grow at a more “moderate” pace in 2011, he added.