UPDATE 2-Mexico central bank says could cut rate if growth slows

Fri Jan 18, 2013 11:53am EST

Related Topics

* Banco de Mexico holds interest rate at 4.5 pct

* Central bank moves to easing bias on rates

* Bank sees downside risks to growth, tamer inflation

By Krista Hughes and Michael O'Boyle

MEXICO CITY, Jan 18 (Reuters) - Mexico's central bank held borrowing costs steady on Friday, but said it could cut interest rates if inflation continues to cool and economic growth flags, dropping its recent threat to tighten policy.

Policymakers said inflation appeared to be in a downtrend in Latin America's second biggest economy after a recent spike, while noting that exports were being hurt by weak global growth.

"It may be advisable to reduce the overnight interbank interest rate to allow the economy to adjust to a situation of lower economic growth and lower inflation," the central bank said in a statement.

Late last year, the central bank had threatened to hike rates after a jump in inflation. Although analysts had expected the bank to back away from that threat, the mention of a possible cut to borrowing costs took the market by surprise.

Mexico's peso weakened and yields on Mexican interest rate swaps fell as investors began to price in the chance of a cut over the next two years.

Analysts doubted, however, the central bank would cut interest rates anytime soon as it monitors both growth and inflation.

The Banco de Mexico left its benchmark interest rate steady on Friday at 4.50 percent, as expected by 20 analysts polled last week by Reuters.

"What we have to evaluate after the dust settles in the coming weeks is if they will cut or not," said Benito Berber, an analyst at Nomura Securities in New York. "That is going to be a function of what happens with the growth data."

Solid U.S. demand has helped shield Mexico from more sluggish growth around the world. Still, the government sees growth slowing from an expected 3.9 percent in 2012 to 3.5 percent this year.

The central bank said the pace of growth was not pressuring inflation while some components of domestic spending have fallen along with exports.

Data last week showed the annual pace of Mexican consumer price increases dipped to 3.57 percent in December, below the central banks 4 percent limit. The rate hit a 2-1/2-year high in September on a spike in food costs, which has faded.

The central bank said on Friday that inflation should remain below 2012 levels this year and stay close to 3 percent.

BARK, NO BITE?

The yield on Mexico's two-year interest rate swap , one of market players' most popular vehicles to bet on monetary policy, bid nearly 16 basis points lower, on track for its biggest one-day drop since last May.

Mexico's central bank has convinced the market previously that an interest rate cut was coming, only to disappoint investors.

"Our formal call continues to be that they are not going to cut this year," said Ezequiel Aguirre, a strategist at Bank of America in New York. "But the market takes it as though the possibility is increasing."

Analysts expected the recent exit of Deputy Governor Jose Julian Sidaoui, who was considered one of the board members most concerned about inflation, would contribute to a statement that expressed less worry about consumer price increases.

Friday's decision was taken by four members. Congress still needs to approve economist Javier Guzman, who was nominated last month by President Enrique Pena Nieto in his first month in office.

Inflation expectations have remained largely stable. A poll from Banamex last week showed the median of economists expect the annual rate will end 2013 at 3.79 percent, up 4 basis points from a poll in December.

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