May 5, 2016 / 6:45 PM / 4 years ago

UPDATE 1-Mexico central bank holds steady but flags risk from weak peso

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MEXICO CITY, May 5 (Reuters) - Mexico’s central bank held borrowing costs steady on Thursday but said financial volatility could again increase and that it would monitor risks to inflation from currency weakness.

The Banco de Mexico left its key rate at 3.75 percent, as expected by all 25 analysts surveyed by Reuters this week.

The central bank, however, said it could not rule out renewed financial volatility and stuck to a warning that it could raise interests at any time, if needed.

Mexico’s peso has gained nearly 6 percent since the central bank unexpectedly raised rates by 50 basis points in February and directly intervened in the foreign exchange market for the first time since 2009 to try to halt a slide in the currency.

The peso’s comeback has eased concerns that currency weakness could hit inflation expectations, while weak U.S. data has sown doubts about how quickly the U.S. Federal Reserve could raise interest rates this year.

The central bank said it would closely watch U.S. monetary policy. Mexico is expected to raise borrowing costs along with the U.S. Federal Reserve to prevent foreign investors from dumping local debt as U.S. interest rates rise.

Still, the peso suffered sharp losses in the last three days, and the central bank maintained recent language that suggests it could hike rates even before the Fed if currency weakness fans inflation expectations.

So far, the pace of consumer price gains has been surprisingly low. Mexico’s annual inflation rate rose less than expected in the first half of April, to 2.60 percent, remaining below the central bank’s 3 percent target.

The bank said on Thursday that inflation would likely creep above 3 percent in the final months of the year, but that the annual pace of consumer price gains would be “practically” 3 percent by the end of the year.

The central bank said domestic demand drove Mexico’s growth in the first quarter, which preliminary data showed was faster than expected. However, policymakers said the risks to growth were still tilted to the downside.

Mexican policymakers are seen delivering one 25-basis-point hike in the third quarter, a Reuters poll showed earlier this week, after the modest recovery in the peso and renewed concerns about U.S. growth and demand for Mexican exports. (Reporting by Michael O’Boyle and Gabriel Stargardter; Editing by Dan Grebler)

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