UPDATE 3-Mexico inflation less than expected in early Jan

(Adds reaction in currency market)

By Jason Lange and Noel Randewich

MEXICO CITY, Jan 24 (Reuters) - Mexican inflation was less than expected in the first two weeks of 2008, increasing investors' bets the central bank could cut interest rates this year to protect the economy from a looming U.S. recession.

Consumer prices <MXCPIF=ECI> rose 0.27 percent in the first half of January, pushing 12-month inflation up 2 basis points to 3.78 percent, the central bank reported on Thursday.

Closely watched core inflation <MXCPIH=ECI>, which strips out some volatile food and energy prices, was 0.25 percent during the period.

"The inflation data was good, and it points to a cut," a Mexico City-based money market trader said. "The central bank has room to cut as long as inflation doesn't get worse."

Analysts in a Reuters poll ECONMX on average had predicted 0.36 percent headline inflation and 0.35 percent core inflation for the first half of the month.

After the report was released, yields fell on interest rate futures contracts for the first half of this year TII:, with the April TIIE future TIIK8 down 7 basis points to 7.84 percent.

That meant investors were betting the central bank was more likely to lower its benchmark overnight interest rate from 7.50 percent.