Governments from the U.S. to Italy are boosting sales ofinflation-linked bonds, wagering consumer prices will remain incheck even after central banks inundated the world with cheapcash.

Thirty-five nations issued $1 trillion of the securities in thepast three years, the most on record, according to data compiled byBloomberg. The amount of government debt in developed countriestied to consumer prices is now equal to 7.9 percent of thefixed-rate sovereign bond market, the most since 2008, index datacompiled by Bank of America Merrill Lynch show.

While cost-of-living increases in the industrialized world havenever been smaller during an expansion, demand for the notes showsinvestors aren't ready to declare that inflation is dead yet aftercentral banks from the U.S. to Japan printed record amounts ofmoney to kick-start their economies. In emerging markets, a currency rout roiling nations from South Africa to Turkeyis already igniting inflation and threatening to add billions ofdollars to government debt costs.

“A number of countries that issued index-linked bonds have beenthrough a recession in the past few years, so naturally they thinkinflation will remain low for a long time,” Salman Ahmed, theglobal strategist at Lombard Odier Investment Managers, whichoversees $46 billion, said in a telephone interview from London.“But some investors seem to have the opposite view. If inflationsurges more than borrowers envisage, they could become an expensiveform of funding.”

Known as linkers, the bonds allow investors keep pace withinflation because the value of the securities increases as consumerprices rise. When living expenses remain low, issuers can reducetheir upfront borrowing costs because linkers pay less in interestthan fixed-rate securities.

In the U.S., $15 billion of 10-year Treasury Inflation ProtectedSecurities, known as TIPS, were sold at a yield of 0.661 percent onJan. 23. Similar-maturity fixed-rate Treasuries yielded 2.78percent on the same day.

Yields were 0.51 percent on the TIPS and the 2.68 percent on thenominal notes today as of 1:00 p.m. in New York.

Demand for linkers has increased as central banks globallydropped interest rates to record lows following the financialcrisis and the Federal Reserve, the Bank of Japan, and the Bank ofEngland flooded the world with money by buying bonds.

Since 2007, central bank assets around the world have almostdoubled, to $20.5 trillion, under asset-purchase programs designedto boost growth and prices, according to a June report from theBank for International Settlements.

Issuance Surges

Sales of linkers worldwide have exceeded $300 billion for threestraight years, the first time that's happened on record, datacompiled by Bloomberg show.

Last year's $315 billion in issuance helped increase the marketfor inflation-linked debt since the end of 2010 by almost 40percent to about $2.3 trillion, the data show.

The U.S., the world's largest debtor nation, issued a record$155 billion last year. Italy, the second-largest seller of linkersin dollar terms in 2013, offered 46 billion euros ($63 billion),more than double the amount in 2008.

A number of countries have also resumed sales or started issuingfor the first time. Japan issued the debt securities last quarterafter a five-year hiatus. New Zealand began selling linkers inOctober 2012 for the first time since 1999.

Spain and Belgium said they plan to introduce the notes ifmarket conditions allow.

“As long as there is some inflation risk premium priced in,meaning inflation expectations are above what the market prices islikely to occur, then there's an argument to issue such bonds,”Anton Heese, head of European inflation research at Morgan Stanley,said in a telephone interview from London.

The gap between five- and 10-year index-linked bond yields inthe global market widened to 0.69 percentage point last month, morethan at any time since 2011, according to index data compiled byBank of America. The so-called steeper real yield curve is a signof increasing risk that living costs globally will rise at a fasterpace as the decade progresses.

Price-growth expectations in the euro region, as implied by thegap between five- and 10-year inflation swap rates, widened to 0.47percentage point on Feb. 7, the most since July 2012. In the U.K.,a gauge of inflation expectations in the five years starting 2019,known as five-year, five-year forward break-even rate, was at 3.33percent today. That's more than the average 3.27 percent over thepast three years.

Living Expenses

While countries that issued linkers benefited by lowering theirdebt costs, investors in the bonds suffered unprecedented losseslast year as price pressures from central bank stimulus dissipated,signs of disinflation emerged, and the Fed moved to curtail its bond purchases.

Consumer prices for advanced economies increased 1.4 percentlast year, according to the International Monetary Fund. Livingexpenses have never risen less during an expansion since at least1980, the first year the IMF figures begin. When the jump in linkersales began in 2011, inflation was 2.7 percent.

Linkers in developed nations lost 4.5 percent last year, thefirst decline since at least 1997, index data compiled by Bank ofAmerica show. In the U.S., TIPS tumbled 9.4 percent in the biggestannual drop since they were introduced 16 years ago. Living costsin the world's largest economy rose 1.48 percent last year, theleast since prices fell in 2009 and less than half the pace in2011.

This year, inflation-linked bonds in developed markets have alladvanced, with securities issued by Germany producing their bestJanuary returns since 2008. Demand for 52-year notes in a U.K. salelast month reached a record, a sign that investors are hedgingtheir bets on inflation.

“What the market is telling you is that there is low expectationof deflation risk going forward,” Kari Hallgrimsson, head ofEuropean inflation trading at JPMorgan Chase & Co. in London,said in a telephone interview. “The market is expectingnormalization of inflation. Expectations for the future are higherthan they are now.”

A one-percentage point increase in consumer prices could raiseItaly's funding costs on its linkers by about 17 billion euros,according to Morgan Stanley. Living costs in the euro region, towhich Italian index-linked bonds are tied, will rise 1.5 percentnext year after gaining 1.1 percent this year, the median forecastof economists in the Bloomberg survey showed.

The tying of bonds to prices dates back to at least the 18thcentury, with the state of Massachusetts issuing bills linked tothe cost of silver on the London Exchange in 1742.

Disinflation Risk

Israel was one of the first countries to offer inflation- linkeddebt when it issued the securities in 1955. The U.K. began sellingin 1981, while the U.S. followed in 1997.

Prolonged disinflation may still be the greater risk indeveloped markets, especially in the euro region as joblessnessabove 10 percent constrains consumer demand.

Inflation in the 18 nations that share the currency was 0.7percent in January from a year earlier, less than half the EuropeanCentral Bank's target and the fourth straight reading below 1percent. As recently as November 2011, consumer prices climbed at a3 percent annual pace.

“It could take years for these problems to resolve,” JamieStuttard, head of international bond management at FidelityInvestments, which oversees $1.7 trillion, said in a telephoneinterview from London. “There is a strong sign of disinflationparticularly in euro zone.”

The opposite is happening in emerging markets, where inflationis accelerating. Price pressures are being compounded by investorspulling money from developing nations as the Fed scales back itsstimulus, weakening currencies from the Turkishlira to the South African rand.

Emerging-market currencies have swooned, with the lira plungingto a record and the rand tumbling to the lowest since 2008. InLatin America, an index tracking the region's foreign-exchangerates slumped to the weakest in a decade this month. Currencydepreciation adds to price pressure by making foreign goods moreexpensive to buy.

Turkey responded by more than doubling its benchmark interestrate to 10 percent and South Africa lifted rates for the first timein five years. Still, Goldman Sachs Group Inc. predicts inflationin developing nations will rise to 4.4 percent by 2015 from 3.8percent at the end of last year.

More Worried

That may result in higher servicing costs for linkers. In SouthAfrica, where the inflation rate rose to 5.4 percent in Decemberfrom a low of 3.4 percent in 2010, the government would incur anextra 1.69 billion rand ($152 million) for every 10 billion rand ofissuance if living costs rise to the 6.4 percent implied by the10-year break-even rate.

The country has 188 billion rand in linkers, according to datacompiled by Bloomberg.

While the currency rout may accelerate price increases inemerging markets as the Fed continues to pull back, U.S. policymakers pledged to keep their five-year-old policy of near-zerorates to support consumer demand. At the same time, Barclays Plc,Commerzbank AG, and Morgan Stanley all predict the ECBwill cut its key rate from a record-low 0.25 percent.

“In the long-term, we are worried about inflation,” DavidHooker, a senior money manager at Insight Investment ManagementLtd., which has $450 billion in assets, said in a telephoneinterview from London. “While the short-term outlook is benign, weare beginning to wonder if the outcome of the current policy is oneof much higher inflation.”

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