Mexico peso sets 1-month high in wake of downgrade

* Peso hits 1-month high on priced-in debt downgrade

* IPC stock index rises 1.5 pct, bonds also gain

* Stable outlook curbs fears of further downgrades

* Country's assets could extend rally on recovery hopes (Adds peso's closing price)

By Michael O'Boyle

MEXICO CITY, Nov 23 (Reuters) - Mexico's peso rose to a one-month high on Monday after Fitch Ratings delivered a widely expected debt downgrade, and the currency could be poised for further gains as the country climbs out of recession.

Many market players had expected both Fitch and S&P could cut their ratings on the country, which allowed the currency to brush off news of the downgrade as it had already been priced in by markets, traders and analysts said.

With the threat of downgrade behind it, Mexico could enjoy more investment flows on expectations of a recovery in its battered exports.

"Most of the bad news for the peso is behind, and now maybe the market can focus on the good news, like the better growth prospects ahead," said Flavia Cattan-Naslausky, a strategist at RBS in Stamford, Connecticut.

The peso MXN=MEX01 gained 0.82 percent to 12.9667 per U.S. dollar following the news, and closed at its strongest level since Oct. 22. For more see [ID:N23261132], [ID:nN23261611] and ID:nN2389048].

The government's benchmark 10-year peso bond MX10YT=RR was bid down 3 basis points to 7.87 percent while the IPC stock index .MXX closed up 1.5 percent at 31,126.17.

Supporting gains, stocks rose sharply worldwide as upbeat economic news in the euro zone and better-than-expected U.S. home sales bolstered demand for riskier assets.

Fitch cut its sovereign debt rating one notch but put Mexico on a stable outlook, easing worries of further downgrades from the agency, which could have endangered Mexico's investment grade.

"The fact that they put it as stable is what calmed the market," said Salvador Orozco, a currency and debt strategist at Santander in Mexico City. "If S&P decides to cut their rating, they will do it in the same way," he added.

GROWTH RALLY AHEAD

The credit default swap market had largely downgraded Mexico's debt since early this year, when the cost of insuring against a default on Mexico's debt spiked above the price for Brazil's, which has a lower debt rating than Mexico.

Investors largely shunned Mexican assets during this year's emerging market rally, pouring funds into other countries with better growth prospects such as Brazil.

That helped Brazil's currency, the real (BRBY), gain around 35 percent this year, while the peso had risen less than 7 percent due to looming worries about the downgrade.

"The obstacle has been overcome and now the peso can move with the rest of the currencies," said Manuel Galvan, an analyst at MetAnalisis consultancy in Mexico City.

Recent comments from U.S. Federal Reserve officials have reinforced expectations that the Fed will keep interest rates near zero well into 2010, boosting the appeal of higher-yielding emerging market assets.

RBC said in a note that the peso could gain a further 3.6 percent to 12.50 per dollar, helped by perceptions that the peso is cheap, compared with other emerging market currencies as well as by growing hopes for Mexico's economic recovery.

Data on Friday showed Mexico marked the end of one of the world's deepest recessions in the third quarter, its economy growing for the first time in a year due to stronger demand in the United States for exports such as cars and steel. [ID:nN20235639]

Standard & Poor's could still also downgrade Mexico, but analysts said its move could be similarly blown off by the market and some think S&P won't follow suit.

"Ultimately, we believe an S&P downgrade is not a short-term risk," RBC said in a note to clients, noting it saw a 30 percent chance of a downgrade from Standard & Poor's.

In stock trading, shares of America Movil (AMXL.MX), Latin America's biggest cell phone operator, rose 1.43 percent to 31.19 pesos.

Shares of small telecommunications firms jumped after regulator Cofetel set preliminary terms for long-awaited wireless frequency auctions, which could help boost competition in the sector. [ID:nN23246267]

Axtel (AXTELCPO.MX) gained 3.91 percent to 12.21 pesos while Maxcom (MXCMCPO.MX) rose 7.16 percent to 8.23 pesos. (Additional reporting by Jean Luis Arce and Lorena Segura) ((Michael.Oboyle@thomsonreuters.com; Tel: +5255-5282-7153; Reuters Messaging: michael.oboyle.reuters.com@reuters.net))