UPDATE 4-Mexico's Carstens ready to act if inflation keeps rising

Tue Oct 30, 2012 5:47pm EDT

* Mexico "close" to an interest rate hike unless inflation cools

* Central bank will act if price spike hits inflation expectations

By Luis Rojas and Michael O'Boyle

MEXICO CITY, Oct 30 (Reuters) - Mexico's central bank is getting close to tightening borrowing costs if inflation does not cool in the coming months and threatens future expectations on consumer prices, central bank chief Agustin Carstens said on Tuesday.

The central bank held its benchmark interest rate steady at 4.50 percent last week though policymakers said they could tighten monetary policy soon for the first time in four years if price pressures do not abate.

A jump in some fresh food prices drove Mexico's annual inflation rate further and further above the central bank's 4 percent limit for four months in a row but the rate fell in the first half of October.

Carstens said it was "very likely" that inflation had peaked and would cool in the coming months.

"If those changes in the trend that we have just started to see do not consolidate, then it would be necessary to use the central bank's monetary instruments," Carstens said at an event in Mexico City.

Yields on interest rate swaps edged up following his comments as the market priced in a greater chance for an interest rate hike next year.

The market bolstered bets on a hike next year after last week's statement, the most hawkish since Agustin Carstens took the helm of the central bank in January 2010.

Mexico's key interest rate has held steady since July 2009 after it was cut amid a deep recession.

"GETTING CLOSE"

Inflation in Mexico has been fueled most by volatile fresh food prices, including a spike in egg prices following an avian flu outbreak. The annual rate rose to 4.77 percent in September, but then dipped to 4.64 percent in early October.

Carstens said higher interest rates were not an "optimal" instrument to fight transitory price changes, such as volatile food costs. However, he said that repeated price shocks could affect inflation expectations and spur price contagion.

"When this danger increases it is appropriate that the central send a signal and, really, we are getting close to that point, unless inflation starts to fall again," Carstens said.

So far, there has not been a sharp increase in mid-term inflation expectations.

At the start of June, before data showed inflation rose above 4 percent, analysts projected the annual rate for 2013 at 3.65 percent, according to the central bank's monthly poll of analysts. By October, 2013 estimates had risen to 3.76 percent.

Banco de Mexico, which has an inflation target of 3 percent, with a one percentage point tolerance band, said last week that recent gains in the peso should help cool Mexican inflation.

Slower growth is also expected to keep a lid on price pressures. Mexico's economy grew an average 4.3 percent in annual terms in the first half of the year, but the finance ministry is forecasting a more moderate expansion of 3.5 percent to 4.0 percent for the whole of 2012.

The yield on Mexico's 2-year interest rate swap bid up 2 basis points to 5.06 percent.

"Rates got pressured with the comment that if the (declining inflation) trend does not consolidate it would be necessary to use monetary policy instruments, meaning increase rates," said a debt trader in Mexico City.

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