UPDATE 2-Mexico central bank holds interest rates, sees better growth

Fri Apr 25, 2014 12:21pm EDT

(Adds market reaction, central bank and economist comments)

MEXICO CITY, April 25 (Reuters) - Mexico's central bank kept interest rates on hold on Friday, noting tame price pressures and highlighting signs of improving economic growth that bode for steady borrowing costs ahead.

The Banco de Mexico maintained its benchmark interest rate at a record low of 3.50 percent, as expected by analysts polled by Reuters.

The central bank said growth in the United States, Mexico's top trading partner, was getting stronger. Policymakers pointed to rising Mexican exports and higher public spending that suggested the economy was improving after a weak start of the year.

"Downside risks to economic activity growth remain, though the balance of these improved marginally," the bank said in a statement.

Mexican annual inflation eased for the third month in a row in early April and policymakers are seen holding rates steady into next year, in contrast with top regional economy Brazil which has raised interest rates to fight inflation.

Yields on shorter-term Mexican interest rate swaps ticked up as traders were surprised by the more optimistic tone of the central bank, analysts said. Investors firmed bets on a 25 basis point interest rate hike in March 2015.

Policymakers said their outlook on inflation was unchanged versus a March decision.

Cooling inflation after a spike in January from new taxes has given the bank room to support weak growth, which sank to a four-year low of 1.1 percent last year.

Minutes from the central bank's last meeting in March showed most policymakers think they need to cut their economic growth forecast for this year of 3 percent to 4 percent. Analysts have cut their estimates to around 3 percent this year.

The central bank said it saw "incipient signs" of stronger consumption and investment. Data on Friday showed Mexico's economy expanded in February at the fastest pace in seven months on a rebound in the service sector.

But several analysts said they were surprised by the bank's view that growth was improving, after data this week showed February retail sales fell for a third month in a row, underscoring faltering domestic demand.

"We just don't see any improvement - not even incipient - in domestic consumption and investment just yet," Nomura analyst Benito Berber wrote in a note.

Mexico's central bank cut its benchmark interest rate three times last year. If growth remains weak, the central bank has little room to further lower borrowing costs since the U.S. Federal Reserve has begun to unwind its monetary stimulus.

Foreign investors have amassed a record 1.9 trillion pesos ($145 billion) of local currency debt and any move to lower Mexican interest rates as U.S. yields rise could undermine the appeal of local assets and weaken the peso currency. A weaker peso could fan inflation by driving up import prices.

Mexico's central bank noted in its statement that flows to emerging markets had resumed in recent weeks as worries about the impact of tighter U.S. policy on global markets eased.

Still, analysts point out that renewed global concerns could hit Mexico hard, due to the liquidity of its bonds and currency. (Reporting by Michael O'Boyle and Alexandra Alper; Editing by W Simon and Chizu Nomiyama)

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