UPDATE 3-Brazil inflation jumps, increasing bets for rate hike

* IPCA index rises 0.60 percent in February

* Rousseff to announce more tax breaks to tame prices

* Market shows increased bets for interest rate hikes

* Brazil's currency hits strongest level since May

SAO PAULO, March 8 (Reuters) - Inflation in Brazil jumped more than expected in February despite a government-sponsored cut in electricity rates, raising prospects of an interest rate hike even as policymakers fret about a sluggish economy. Brazil's benchmark IPCA consumer price index rose 0.60 percent in February, statistics agency IBGE said on Friday, above all 39 forecasts in a Reuters poll. The index had risen 0.86 percent in January. In another bid to tame prices, President Dilma Rousseff will announce later on Friday the elimination of federal taxes on staple foods. The move has been expected since early February, but its impact on inflation is not yet clear. Yields on interest rate futures jumped on the Sao Paulo BM&FBovespa exchange as traders increased bets that Brazil's central bank would lift its overnight lending rate as early as next month. Brazil's currency, the real, rose past 1.95 per dollar for the first time since May as some investors bet the central bank would welcome a slightly stronger exchange rate to help tame inflation. In the 12 months through February, inflation rose 6.31 percent, the biggest increase since December 2011. The central bank targets inflation at 4.5 percent, with a tolerance band of plus or minus 2 percentage points. The inflation report "pushes the central bank up against the wall," Enestor dos Santos, an economist with BBVA in Madrid, said in a research note. Government officials, however, were more sanguine about the inflation outlook. Speaking to reporters in Brasilia, Deputy Finance Minister Nelson Barbosa said inflation was under control and would slow "gradually" throughout the year on lower international food prices. He also said inflation would converge toward the center of the target range at the "adequate" moment. Rousseff has slashed taxes on dozens of products to revive an economy that has struggled to grow in the last two years. Some of those cuts have also been aimed at easing inflation that is rapidly becoming a headache for her administration. The elimination of federal taxes on staple foods could trim about 0.4 percent off inflation, according to local newspaper Valor Economico, which cited unnamed government sources. Without the cut in power rates announced in January, which slashed 0.48 percentage point from February's IPCA index, 12-month inflation would have already topped the target ceiling. "Inflation should surpass the target ceiling as early as March," said Flavio Serrano, an economist with Espirito Santo Investment Bank. The index had been expected to rise 0.49 percent in February, according to the median forecast in the Reuters survey. Estimates ranged from 0.38 percent to 0.56 percent. Services prices, boosted by record-low unemployment and a steep rise in wages over the past few years, rose 1.30 percent from January, the highest monthly reading since February 2009, according to a report from Nomura. Prices of 72.3 percent of items surveyed by IBGE rose in February, slightly below January's percentage but still at a high level, analysts said.

Rising inflation has complicated Rousseff's efforts to bolster the economy. The central bank, which slashed interest rates 10 consecutive times between August 2011 and October 2012 to an all-time low of 7.25 percent, this week suggested it could raise them as early as next month. The bank dropped a reference in its statement about maintaining low rates for a prolonged period. A Reuters poll on Thursday showed a slight majority of economists already expected a rate increase this year. Electricity prices dropped 15.17 percent in February, IBGE said, driving housing costs down by 2.38 percent. However, food inflation slowed only modestly, with an increase of 1.45 percent in February versus a 1.99 percent jump the previous month, while education costs soared 5.40 percent because of annual tuition increases nationwide. Below is the result for each price category:

January February - Food and beverages 1.99 1.45- Housing -0.20 -2.38- Household articles 1.15 0.53- Apparel -0.53 0.55- Transport 0.75 0.81- Health and personal care 0.73 0.65- Personal expenses 1.55 0.57- Education 0.35 5.40- Communication -0.08 0.10- IPCA 0.86 0.60