January 31, 2014 / 3:50 PM / 4 years ago

UPDATE 2-Mexico cbank holds rate, eyes peso for any inflation impact

By Gabriel Stargardter and Christine Murray

MEXICO CITY, Jan 31 (Reuters) - Mexico’s central bank kept interest rates on hold at a record low on Friday, as policymakers seek to underpin a nascent recovery while keeping an eye on the country’s currency, whose weakening could contribute to accelerating inflation.

The Banco de Mexico maintained its benchmark interest rate at 3.50 percent, as expected by analysts polled by Reuters, after cutting rates in September and October to boost growth.

In a statement announcing the interest rate decision, the central bank board said the Mexican peso’s swings could increase the risk of more inflation, which has breached the bank’s target ceiling.

“There is the possibility that a new period of increased volatility in international financial markets could lead to a currency adjustment which could potentially affect inflation,” it added.

Mexico’s annual inflation rate in mid-January shot up to 4.63 percent, its fastest pace in eight months and well above the central bank’s upper policy limit of 4 percent.

The bank said that while the rise in inflation was probably temporary, it could not discount it having a more durable impact.

“You cannot rule out the risk that the recent adjustments in relative prices could lead to increases in medium-term inflation expectations that could lead to second round effects,” the bank statement said.

The Mexican peso has weakened 2.8 percent this month against the dollar as investor jitters mounted on a worldwide emerging markets sell-off.

There was no mention of any possible rate adjustment in the statement by the central bank, the Banco de Mexico (Banxico).

But the central bank’s stance raised questions if any interest rate hike may come later this year.

“(The statement) is important because it means that maybe because of the volatility in the markets, in the FX markets, Banxico could move sooner than expected,” said Nomura Securities senior Latin America strategist Benito Berber, who noted the bank’s “neutral” statement had “a little bit of a hawkish flavor.”

“It could be that they move, if volatility continues and the economy grows, say in the second half of 2014,” he added. “What is even more interesting is that the (yield) curve is going down, meaning that the market was positioned for an even more hawkish statement.”

Mexico’s central bank governor Agustin Carstens said in an interview published this week the bank was weighing whether monetary policy needs adjusting after a spike in inflation, but he also expected the price surge to be temporary.

Carstens said he expected food prices, a major component of the consumer price index gauge and which have recently risen, to correct during this year, while other prices linked to fiscal policy would correct within a year. He also suggested a rate hike would not help correct current price pressures.

In a Reuters poll last week, the median of analysts surveyed projected the central bank will raise its benchmark rate to 3.75 percent in the first quarter of 2015, pushing back expectations for a hike in the second half of this year in the previous poll.

“Overall I see no indication of a near-term or a short-term change in monetary policy, but they remain vigilant if things deteriorate from here,” said Alberto Ramos, senior Latin America economist at Goldman Sachs in New York, adding that he expects an interest rate hike to come toward the end of 2014.

Following aggressive hikes by South Africa and Turkey this week, yields on Mexican short-term interest rate swaps rose sharply to price in a rate rise as soon as July .

Mexico’s central bank lowered borrowing costs in September and October after an economic contraction in the second quarter and policymakers have been expected to keep borrowing costs steady amid a tepid recovery in U.S. demand for Mexican exports.

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