Unexpected increase in retail sales adds to inflation fears Five-year breakeven inflation rate highest since April 2005 Adds comment, new prices by Herbert Lash NEW YORK, Oct 15 Reuters - Treasury yields rose and an accompanying market indication of inflation expectations hit the highest since 2005 on Friday as an unexpected increase in U.S. retail sales in September added to bearish bond sentiment over the course of interest rates The yield on benchmark 10-year U.S. Treasury notes rose 4.9 basis points to 1.569% amid fears that supply constraints could disrupt the holiday shopping season amid continued shortages of motor vehicles and other goods. Retail sales rose 0.7% last month and data for August was revised higher to show retail sales increased 0.9% instead of 0.7% as originally reported by the Commerce Department. The September sales were partly lifted by higher prices. There's a huge bearishness in the market from a lot of hedge funds and big macro accounts that think rates are going to go up another 50 basis points by year-end or early next year, said Tom di Galoma, a managing director at Seaport Global Holdings in Greenwich, Connecticut. The Federal Reserve could begin to taper its massive bond purchases in December but would probably hold off on increasing the federal funds rate for the moment, di Galoma said. The breakeven rate on five-year U.S. Treasury inflation - protected securities TIPS was last at 2.727% after hitting 2.753% early, the highest since April 2005. The Fed's insistent that high consumer prices are transitory has been thoroughly debunked by now, says David Petrosinelli, senior trader with InspereX. The gorilla has been in the room for a long time, but maybe the gorilla was a little too quiet, Petrosinelli said about inflation. Now they realize there s a gorilla in the room. The cost of buying a home and more recently, rising rental prices are clear signs of rising inflation, not to mention higher gasoline prices, he said. If people believe there is inflation, that's when inflation is self-fulfilling, Petrosinelli said. Investors look forward to the next week auction of $24 billion in five-year bonds and $19 billion in 20- year TIPS announced by Treasury. The yield on the 30 year Treasury bond was up 2.7 basis points to 2.052%. A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two - and 10-year Treasury notes, seen as an indicator of economic expectations, was at 117.6 basis points. The two year US Treasury yield, which typically moves in step with interest rate expectations, was up 3.7 basis points at 0.391%. The breakeven on the next 10 year TIPS rate was last at 2.556%, suggesting the market sees inflation of almost 2.6% a year for the next decade. The U.S. dollars forward inflation-linked swap saw by some as a better gauge of inflation expectations due to possible distortions caused by the Fed's bond buying was last at 2.553%.