Brazil to end rate rises as slowdown mounts
* Brazil seen ending rate-hike cycle as economy slows
* Inflation fears likely to prevent a cut
* Some betting on a surprise cut following gov't steps
RIO DE JANEIRO, Aug 31 (Reuters) - Brazil's central bank will likely call a halt to this year's flurry of interest rate hikes on Wednesday as it responds to growing signs of a slowdown in Latin America's largest economy.
With annual inflation running above 7 percent, policymakers will be reluctant to start reducing the country's lofty borrowing costs just yet and are expected by economists to leave the benchmark Selic rate at 12.5 percent.
Investors have swung in recent weeks from expecting a significant fall in rates this year to forecasting little or no change. They will be closely watching the bank's statement for signs of a more dovish stance in the months ahead.
A few have even started to bet on a surprise rate cut on Wednesday night following signals from the government in recent days that it wants a monetary easing sooner or later.
President Dilma Rousseff's government said this week it would maintain spending discipline for the rest of 2011, hoping to reduce demand pressures in the economy and pave the way for a cut in interest rates that are among the world's highest.
"From this moment we want to have the possibility of rate cuts," Rousseff said in a radio interview on Tuesday.
"We opened the path to have falling rates, or rates that start to fall."
Clear evidence of an economic slowdown has emerged in the past few weeks as Brazil feels the impact of global financial problems in addition to a natural cooling from unsustainably strong growth of 7.5 percent last year.
Economists have been cutting their GDP forecasts for the year to 3 to 4 percent as signs mount that Brazil's indebted consumers are running out of steam and the manufacturing sector suffers from foreign competition and a strong currency.
The problem for the government and the central bank is that inflation pressures stemming from a strong job market and a lack of investment in infrastructure show few signs of dimming.
Twelve-month inflation through mid-August climbed to 7.1 percent -- well above the target ceiling of 6.5 percent.
All 20 analysts polled by Reuters expected the Selic rate to remain at 12.5 percent this week. All but two of them also expected the rate to remain unchanged through the end of the year following five interest hikes since the start of 2011.
The poll was taken before the government's announcement this week that it would raise its target for its primary budget surplus this year in a bid to slow the growth of spending.
"The market has seen the pressure from the government, the comments that President (Rousseff) is not happy about the level of rates. We also know that the central bank is listening too," said Rafael Dornaus, a trader at Hencorp Commcor, a Sao Paulo securities brokerage.
"While it's unlikely, there are a lot more people ready to bet on a rate cut tomorrow."
Rousseff and other officials have said the central bank has full control over when it chooses to cut rates.
Interest rate futures <0#DIJ:> have swung sharply in recent weeks. At one point, they incorporated expectations of a 12 percent Selic rate by September. But they have quickly returned in line with economists' more conservative outlook.
The overnight interest rate futures for Dec. 30 settlement, the so-called January 2012 future DIJF2, fell 2 basis points on Tuesday to 11.92 percent. (Additional reporting by Hugo Bachega and Jeb Blount; Editing by Dan Grebler)