Mexico Holds Rate on Signs of Slowing U.S. Growth

Sep 21, 2007 - Mexico's central bank kept its benchmark interest rate unchanged as a slowing economy in the U.S., the biggest destination for Mexican goods, eased pressure to control rising local food costs.

The five-member board held the benchmark rate at 7.25 percent, matching estimates from 23 of 24 economists surveyed by Bloomberg. The bank maintained a "restrictive bias" that has been in place since May, citing rising food prices and legislation that will introduce a fuel tax.

The U.S. Federal Reserve's cut in borrowing costs to forestall a recession increased concern that a slowdown there will erode Mexico's expansion. Lower U.S. interest rates also make Mexican assets more attractive, potentially strengthening the peso and easing inflation as imports become cheaper.

"The measures taken by the Fed may make it easier for the Bank of Mexico to stay put," said Omar Borla, a senior Latin America economist with Dresdner Kleinwort in New York, in a telephone interview. "The amount of the Fed cut also signals U.S. activity might be slowing more than expected, which would certainly have an impact on Mexico."

Mexico's peso extended gains after the central bank announcement, gaining 0.4 percent to 10.9473 per dollar at 10:14 a.m. New York time.

Future Increase

Mexico's Finance Ministry on Sept. 8 lowered its 2007 growth estimate to 3 percent from 3.3 percent, citing waning demand from the U.S., which buys about 80 percent of Mexico's exports.

A deceleration in the U.S. next year will trim demand for Mexican exports and restrain growth in Mexico to 3 percent even after legislators passed a tax bill aiming to spur economic growth, Shelly Shetty, senior director for sovereign ratings at Fitch Ratings, said yesterday in an interview.

While the bank had reasons to hold rates unchanged today, policy makers said today the inflation outlook has worsened. The bank said it will revise inflation forecasts for the next two years in its quarterly report to be published next month.

"Pressure from food prices has increased more than expected (particularly dairy and wheat)," the central bank said in its statement today. "What's more, we must assess the consequences of the recently approved tax reform."

Banco de Mexico may still have to raise rates again before year-end to reach the bank's inflation targets, said economists such as Borla, Banco UBS Pactual's Guillermo Aboumrad, JPMorgan Chase & Co.'s Alfredo Thorne and Morgan Stanley's Gray Newman.

Rising costs of food staples from tortillas to sugar have pushed inflation to above 4 percent, which policy makers define as the upper limit of their acceptable range, in eight of the past 12 months.

The central bank predicts inflation will fluctuate between 3.75 percent and 4.25 percent during the third quarter before falling to between 3.25 percent and 3.75 percent in the fourth.