WRAPUP 4-Mexico central bank holds interest rates, looks to Fed

Fri Jun 7, 2013 12:51pm EDT

* Interest rates remain on hold at 4.0 percent

* Central bank says risks to economic growth intensified

* Annual inflation cools slightly in May to 4.63 percent

By Michael O'Boyle

MEXICO CITY, June 7 (Reuters) - Mexico's central bank held interest rates at a record low on Friday as growing expectations for the Federal Reserve to ease back on stimulus undermined arguments for lower Mexican borrowing costs.

Policymakers are balancing what they described as deeper risks to economic growth against a spike in inflation that overshot the central bank's ceiling for a third month in May.

The Banco de Mexico kept its benchmark interest rate steady at 4.0 percent, in line with forecasts in a Reuters poll, and said the stance was in line with expectations that price pressures would not spread.

The central bank said it expected annual inflation, which was reported earlier on Friday at 4.63 percent in May, to turn down in June and slide quickly below policymakers' 4 percent limit in the second half of the year.

The central bank also said recent weakness in the country's peso currency could persist, backing away from concerns in April that financial flows to Mexico could push the peso too high.

"As a reflection of possible changes in monetary policy in the United States, volatility in the exchange rate could continue, although the strong fundamentals of the Mexican economy will tend to order its behavior in the medium term," the central bank said in a statement accompanying its decision.

Mexico's peso was hammered in May along with other emerging market assets as convictions grew that the Federal Reserve could begin easing back its monetary stimulus later this year, a move that would strengthen the dollar.

"People had speculated that one of the reasons the bank could cut the interest rate was to deter the appreciation of the peso," said Ezequiel Aguirre, a strategist at Bank of America. "They are not worried about the peso at its current levels."

After a 7 percent slump in the peso last month, economists have warned of the risk to inflation should foreign investors pull out of Mexican assets and weaken the currency further, pushing up import prices.

Markets in May began pricing in a withdrawal of Fed stimulus later this year, driving up yields on Mexican bonds and interest rate swaps and wiping out bets on another 50 basis point cut by Banxico around September.

"The are going to avoid exacerbating the situation of peso weakness, so they have removed this sense that rates could go lower," said Enrique Alvarez, an analyst at IDEAglobal.

Still, some analysts said the bank was still likely to cut interest rates if growth slows in Mexico and the United States, which could keep Fed stimulus steady.

INFLATION SPIKE

The central bank took advantage of a brief window of low inflation early this year to cut its benchmark rate for the first time in nearly four years in March to a new record low in what was seen as a bid to reduce the appeal of local assets.

The May figures showed even though fresh food prices fell in the month, they were again the main driver of annual inflation, up more than 15 percent from the same time last year.

Headline consumer prices fell 0.33 percent in May, from a 0.07 percent rise in April and broadly in line with the 0.3 percent dip expected in a Reuters poll.

The core price index, which strips out some volatile food and energy prices, rose 0.2 percent in the month, in line with expectations.

Non-food core goods inflation, the most sensitive to currency fluctuations, and core services prices, a key gauge of home-grown price pressures, both eased, the figures showed.

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