By Renato Andrade

Brazil’s local-currency bond yields dropped the most in a week on the prospect of further cuts in interest rates after analysts forecast a steeper contraction for Latin America’s largest economy this year.

“The contraction forecast for the economy supports the call for further interest-rate cuts,” said Paulo Petrassi, who helps manage 45 million reais ($22.2 million) in assets at Leme Investimentos in Florianopolis, Brazil.

Economists estimated the country’s gross domestic product will contract by 0.53 percent in 2009, the most since 1990, compared with the previous estimate of 0.49 percent, according to a weekly central bank survey published today.

Policy makers reduced borrowing costs on April 29 to a record low of 10.25 percent to shore up growth in the country. The weekly survey showed analysts expect the bank to cut the so- called Selic rate by 75 basis points in June, to 9.50 percent. Economists expect the rate to fall to 9 percent by year-end.

The yield on the nation’s zero-coupon bonds due January 2010 fell six basis points or 0.06 percentage point, to 9.37 percent at 4:01 p.m. New York time, according to Banco Votorantim.

The real climbed 0.2 percent to 2.0233 per U.S. dollar, from 2.0269 on May 22, as Brazilian stocks advanced. U.S. financial markets are shut for the Memorial Day holiday.

In the overnight interest-rate futures market, the yield on contracts to January 2010, the most-actively traded in the BM&F commodity and futures exchange, declined four basis points to 9.30 percent.

Real’s Rally

The real has gained 14.4 percent so far this year, the second-best performance among the world’s 16 most-actively traded currencies, behind South Africa’s rand.

Brazil’s central bank has purchased dollars daily in the local spot market since May 8, in a bid to temper the real’s advance. Last week, the currency touched 2.0125 per dollar, the strongest in more than seven months.

The bank purchased today another unspecified amount of dollars. The country’s foreign reserves totaled $205.36 billion as of May 22, the central bank said in a separate report released today on its website.

“The market can test the 2 per dollar level this week,” said Francisco Carvalho, head of currency trading at Sao Paulo- based Liquidez Corretora.

The real has climbed 21 percent since March 2, the biggest advance among the six most-traded currencies in Latin America, as prices on the country’s commodity exports rebounded and investor demand for emerging-market assets picked up.

“There is stronger demand for Brazilian assets supporting the currency gain as well as the prospect for an improvement in global demand for commodities which also helps the real,” Miriam Tavares, foreign-exchange director at AGK Corretora de Cambio said in an interview with Bloomberg Television in Sao Paulo.

Brazil has an $8.5 billion trade balance surplus in the year through May 24, an increase from the surplus of $6.7 billion in the same period last year, according to data released today by the Brazilian Trade Ministry.