Mexican bonds still reeling after rates warning

MEXICO CITY, Feb 26 (Reuters) - Mexican government bonds fell sharply and the peso weakened for the second straight session on Monday as investors considered the central bank more likely to raise interest rates soon.

The peso MXN= MEX01 dropped 0.38 percent to 11.081 per dollar, while the benchmark IPC stock index .MXX was off 0.4 percent at 28,393 points.

The central bank said on Friday it would hike rates in March if a five-month spike in inflation does not begin to ease in that month. The announcement, which came in the central bank's monthly monetary policy review, sent bonds tumbling on Friday in their worst day in nearly seven months.

The sell-off continued on Monday.

"Investors are still selling bonds as they have to adjust to the possibility of a hike," said Francisco Diez, an analyst at RBC Capital in Toronto.

The benchmark 10-year local currency bond MX10YT=RR fell 0.447 in price for a yield of 7.88 percent, a 7 basis-point jump. Bond yields move inversely to price.

The benchmark 20-year peso bond MX20YT=RR fell 0.978 in price for a yield of 7.99 percent, a 9 basis-point increase.

Inflation has been above or near the upper limit on the central bank's 2-4 percent inflation target since September, fueled in part by rising prices for staple foods.

In stock trading, leading retailer Wal-Mart de Mexico (WALMEXV.MX) led the decline, falling 1.05 percent to 46.20 pesos. Its shares have fallen every day since government data showed last Tuesday that retail sales increased a below-forecast 1.3 percent in December.

Airport operator GAP (GAPB.MX) (PAC.N) fell 2.76 percent to 47.59 pesos after Merrill Lynch cut its rating on the company to "neutral," citing a 20 percent gain since last October in its shares. Its New York traded shares fell 2.67 percent to $43.03.

Home builder Geo (GEOB.MX) fell 1.45 percent to 65.70 pesos after Merrill Lynch also cut its rating to "neutral" after a recent rally in its share price.