Mexico holds interest rates, watching capital inflows

MEXICO CITY Fri Apr 26, 2013 9:18pm IST

MEXICO CITY (Reuters) - Mexico's central bank on Friday brushed off a recent pick-up in inflation, keeping the door ajar for a possible further relaxation in credit costs if stimulus in advanced economies fans capital inflows.

The Banco de Mexico held its benchmark rate at record low of 4 percent, as expected in a Reuters poll, after it cut borrowing costs for the first time in nearly four years in March.

Markets are pricing in a good chance of another 25 basis point cut in the second half of the year, when inflation is forecast to decline and the bank's statement backed views that a stronger currency is becoming an increasing concern.

Policymakers said a spike in consumer prices that took inflation above the central bank's ceiling in March and early April was transitory and said they saw no broad price pressures. They also highlighted the risk a U.S. economic slowdown could hit Mexico.

"Going forward, the board will continue monitoring all factors that could affect inflation," the central bank said in a statement accompanying the decision.

They pointed, on the one hand, to the risk of knock-on effects from higher fresh food prices but also to the risks that ultra-easy monetary policies around the world could effectively put the brakes on Mexican growth.

Mexico has absorbed $160 billion in new foreign investment in its financial markets in the last three years, pushing stocks .MXX and bonds to record highs. Analysts say stimulus by the Bank of Japan could spur fresh inflows.

"Banxico (Banco de Mexico) has to keep proving that it is, at the end of the day, an inflation targeter, and so has to sound cautious, but clearly their main worry is about capital flows," said JPMorgan economist Gabriel Lozano.

If the peso, which has already gained 6 percent this year, continues to appreciate and if inflation subsides as the bank projects, Lozano said there was a chance of more easing.

Banco de Mexico Governor Agustin Carstens said on Friday that the peso was still undervalued compared to before the 2008 financial crisis.

But he said optimism about the government's drive to pass big economic reforms could fuel more gains and he added that policymakers would need to be vigilant in the case the inflows surge. A too-strong peso could hobble local exporters.

"We are in a floating (exchange rate) regime, if we really continue with big success, well it is probable that the exchange rate will tend to appreciate," Carstens said in a radio interview.

Carstens added that the central bank would likely accumulate another $20 billion in international reserves this year on top of current levels worth nearly $166 billion.

FLAGGING GROWTH

The stronger currency does help keep a lid on inflation by capping the price of imported goods. Annual inflation accelerated to a seven-month high of 4.72 percent in early April, although the central bank said it should start to cool in June and be between 3 percent and 4 percent in the second half of the year.

Banco de Mexico targets inflation of 3 percent, with a one percentage point tolerance zone either side.

Mexico's strong currency contrasts with recent weak data suggesting economic growth slowed in the first quarter of 2013, after picking up at the end of 2012.

Retail sales fell in February by the most in 3-1/2 years and industrial output growth slowed. The trend continued in March, with the jobless rate rising and consumer confidence and factory activity deteriorating for the third month running.

But exports are holding up: separate data on Friday showed factory exports rose in March for the second month in a row, bolstered by a strong rise in auto exports.

(Additional reporting by Jean Luis Arce. Editing by W Simon)

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