UPDATE 4-Mexico central bank unexpectedly cuts rate to spur weak economy

Fri Jun 6, 2014 3:18pm EDT

(Adds details, economic context)
    By Michael O'Boyle and Alexandra Alper
    MEXICO CITY, June 6 (Reuters) - Mexico's central bank
unexpectedly slashed interest rates to a record low on Friday,
saying a sluggish economy gave it room for a one-off cut to spur
growth without fanning inflation pressures.
    The Banco de Mexico cut its benchmark interest rate
 by 50 basis points to 3.00 percent, surprising 21
analysts who had unanimously forecast in a Reuters poll that
rates would stay on hold.
    Latin America's No. 2 economy barely grew in the first
quarter as a harsh winter dragged on growth in the United
States, Mexico's top trading partner, while Mexican tax hikes
hit domestic demand.
    "Given the greater margin of slack in the economy, the
efficient convergence of inflation towards 3 percent is feasible
with a lower reference interest rate," the central bank said in
a statement.
    Policymakers said they did not expect to further cut rates, 
suggesting even lower borrowing costs would not be prudent since
the United States is expected to begin a tightening cycle and
growth in Mexico is forecast to pick up.
    
    
    
    The bank's move stunned markets. Traders reported chaos on
trading floors. Mexican bond yields tumbled and the stock market
rose to its highest level this year, while the peso
currency briefly hit a session low.
    Prices for the county's benchmark 10-year peso bond
 jumped, pushing down its yield by 33 basis points in
the biggest one-day drop since last September. "Banks were
really caught off guard," said one Mexico-based bond broker.
    The cut was surprising given the bank's conservative
reputation. Analysts speculated the decision was split,
reasoning that Gov. Agustin Carstens likely pushed for a bold
cut, overriding concerns of other board members about inflation.
    In its decision, the central bank said inflation risks have
lessened. Annual inflation has been falling since it spiked
above the central bank's 4 percent limit in January, largely due
to new taxes on soft drinks and fast food.
    But policymakers said there were still risks that economic
growth could slow after a weaker-than-expected start to the
year. Last month the government cut its estimate for annual
growth in 2014 from 3.9 percent to 2.7 percent.
    The central bank said despite stronger exports, it was still
worried about weakness in domestic spending.
    The country's central bank had not been expected to lower
its main rate so far below the current inflation rate, which was
3.44 percent in the 12-month period though mid-May.
    In previous years, sharp drops in the peso currency have
made Mexican interest rate cuts risky since lower borrowing
costs could push yield-hungry investors to dump Mexican fixed
income assets and further hurt the currency.
    A weak currency can spur inflation through higher import
prices. Analysts said the central bank was taking advantage of
renewed calm in financial markets and the recent dip in
inflation to shore up economic growth.
    "They seized the moment," said Delia Paredes, an economist
at Banorte bank in Mexico City. "It was quite a surprise."

 (Editing by Simon Gardner, Sofina Mirza-Reid and David
Gregorio)
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