Mexico's cenbank intervenes to shield battered peso

(Adds cenbank, finance ministry confirmation of intervention, paragraphs 2-3, detail on dollar auctions, paragraph 9)

*Central bank surprises market with intervention

*Peso rebounds from record low, firms 0.76 pct

*Currency weakness seen undermining interest rate cuts

By Cyntia Barrera Diaz and Lizbeth Salazar

MEXICO CITY, Feb 4 (Reuters) - Mexico's central bank surprised investors with an intervention to boost the peso on Wednesday, selling U.S. dollars directly to market players after the peso was battered to a record low on fears the U.S. downturn is driving Mexico into recession.

The central bank and the finance ministry confirmed in a joint statement that the bank had sold dollars directly to brokerages and banks in order to stem volatility and add liquidity.

They did not divulge the amount but said the sales would show up in the central bank's weekly international reserves report, due for release next week.

"The Foreign Exchange Commission instructed the central bank to inject liquidity into the market," a source at the central bank, who asked not to be named, said earlier.

The Mexican currency MXN= MEX01 firmed 0.76 percent to 14.47 per dollar at the central bank's final reference rate after hitting 14.70 earlier in the session, its weakest level since new pesos were introduced in 1993.

The peso has been hammered in recent months as the U.S. recession has dampened demand for Mexico's exports. The currency has lost 4.5 percent against the dollar so far this year after a 21 percent slump in 2008.

Mexico's central bank broke its long-held reluctance to intervene in currency markets last October when the global crisis spurred the peso's steepest declines in over a decade.

Since then, the bank has held regular pre-announced auctions of hundreds of millions of dollars at a time but Wednesday's move was a surprise.

The central bank said in its statement on Wednesday that it would continue with daily auctions of up to $400 million under the same mechanism it has been using to date.

"The peso has been very volatile, and the current mechanism in place when they auction dollars is not achieving their goal," said Igor Arsenin, head of debt and currency strategy for Latin America at Credit Suisse in New York.

The last time Mexico intervened in currency markets was during global financial turmoil in 1998.

RATE CUTS

Luis Flores, an economist at IXE brokerage in Mexico City, said the bank was worried that a continued fall of the Mexican currency could push up import costs, fuel higher inflation and prevent policymakers from being able to cut interest rates to boost the flagging economy.

"The central bank wants to lower interest rates, so it's trying to stabilize the peso in a more decided manner," Flores said.

Last month, Mexico's central bank lowered borrowing costs for the first time in nearly three years as it saw the economic downturn outweighing inflation pressures.

Mexico is closely tied to the United States, which buys some 80 percent of its exports. Due to the U.S recession, Mexico's central bank expects the economy could shrink by as much as 1.8 percent this year.

The peso's recent slide has pushed investors to doubt the central bank will lower interest rates as quickly as expected.

The government's benchmark 10-year peso bond MX10YT=RR pared steep losses to break a seven-session losing streak, gaining 0.063 percent of a point in price, pushing its yield up 1 basis points to 7.98 percent.

The central bank has sold nearly $17 billion from its international reserves since October, but it is still flush with dollars from Mexican crude oil sales.

On Tuesday, the U.S. Federal Reserve extended a $30 billion swap line with Mexico, giving the central bank even more ammunition to defend the peso.

Gabriel Casillas, an economist at UBS in Mexico City, speculated in a note to clients earlier on Wednesday that the central bank may have tapped the Fed line to fund Wednesday's intervention in order to conceal the amount it injected.

In the equities market, stocks were little changed, with the IPC index .MXX closing down 0.04 percent at 19,622.60.

Shares in Cemex (CMXCPO.MX), the world's No. 3 cement maker, rose 3.36 percent to 11.98 pesos after the company said it expected to generate $2 billion in free cash flow this year to help pay its loans, more than many investors expected. [ID:nN04279408]

Cemex stock in New York (CX.N) gained 3.24 percent to $8.28. (Additional reporting by Michael O'Boyle and Luis Rojas; Editing by Diane Craft, Gary Hill)