Nov. 10 (Bloomberg) -- Mexico’s peso bonds were little changed, with yields remaining near a one-week low, on bets inflation will continue to slow through year-end.

Yields on Mexico’s 10 percent bond due December 2024 were steady at 8.25 percent at 6:03 p.m. New York time, according to Banco Santander SA. The yield fell to 8.248 yesterday, its lowest since Oct. 29.

Mexico’s annual inflation slowed to 4.5 percent in October from a year earlier, the central bank said in a report yesterday. The median forecast in a Bloomberg survey was for an annual rate of 4.64 percent.

“Inflation was a positive surprise,” said Salvador Orozco, head of fixed-income research at Banco Santander in Mexico City. “It should continue to fall, ending this year at a lower rate.” He forecasts inflation will slow to around 4 percent by year-end, before quickening in 2010 to above 5 percent as the government raises taxes to rein in a widening budget deficit.

The peso’s 1.5 percent gain in the past two days is also helping boost demand for the local bonds, according to Orozco.

“We’ve been seeing some flows from foreign investors,” said Orozco. “The peso’s appreciation has played a role in pushing yields lower.”

The peso erased an earlier drop, gaining 0.5 percent to 13.2131 per U.S. dollar, from 13.2778 yesterday. Today’s advance pares the peso’s drop in the past three months to 2.2 percent, the only decline against the dollar among 16 major currencies tracked by Bloomberg.

Downgrade Concern

Concern Mexican President Felipe Calderon will fail to contain the widening budget deficit enough to avoid the country’s first credit rating downgrade since 1995, is also weighing on the peso, said Vicente Gonzalez, head currency trader at RBS Mexico, a unit of the Royal Bank of Scotland Plc.

Mexican lawmakers are discussing budget reforms necessary to rein in a growing fiscal deficit, with a decision on the spending side due to be approved on Nov. 15. The opposition- controlled Congress approved on Nov. 1 a permanent 1 percentage- point increase in the sales tax to 16 percent after rejecting Calderon’s proposal for a 2 percent consumption tax that would have generated more than double the revenue.

Standard & Poor’s and Fitch Ratings have signaled they may lower Mexico’s credit rating should the government fail to contain the deficit and offset a drop in oil production. Analysts from both rating agencies said last week they are waiting to see the spending side of the 2010 budget before making a decision on the country’s rating.

“We’re approaching the deadline which limits the peso’s gains,” said Gonzalez. “Until we don’t know for sure what will finally happen to the reform,” the peso will trade in a 13.2 to 13.4 range, he said.

To contact the reporter on this story: Andrea Jaramillo in Bogota at ajaramillo1@bloomberg.net

Last Updated: November 10, 2009 18:15 EST