Mexico Keeps Rate at 4% Rate on Outlook Inflation Will Slow

Mexico’s central bank kept borrowing costs unchanged at a record low, with policy makers saying they expect inflation to start slowing back toward their target range in June.

Banco de Mexico maintained the overnight rate at 4 percent today, as predicted by all 19 economists surveyed by Bloomberg. Annual inflation quickened to 4.72 percent in the first half of April, the fastest pace since September, after a frost drove up farm prices. Policy makers target inflation of 3 percent, plus or minus one percentage point.

The central bank, led by Governor Agustin Carstens, lowered its key rate by half a percentage point March 8. The rate cut ended Mexico’s status as the only Group of 20 nation to leave borrowing costs unchanged and refrain from buying bonds to ease monetary conditions since July 2009. The bank said the rate reduction wasn’t the start of an easing cycle, and that it expected inflation to accelerate in the short term before reverting toward its target of 3 percent.

Inflation “should be expected to remain at elevated levels in April and May and resume a downward trend from June to settle in the second half of the year between 3 and 4 percent,” the bank said in a statement accompany today’s decision. “For 2014 we anticipate headline inflation will settle very close to 3 percent.”

Further Cuts

Yields on fixed-rate government peso bonds due in 2024 reversed an earlier drop and were little changed at 4.58 percent at 9:21 a.m. in Mexico City. The peso, which has strengthened since the March 8 rate cut and has rallied 5.6 percent against the U.S. currency this year, increased 0.2 percent to 12.1411 per U.S. dollar.

“If we confirm that inflation resumes a downward trend in a couple of months and the peso continues to strengthen, we could well see further cuts by Banxico this year, especially considering how hesitant they are to intervene in the peso market,” Italo Lombardi, an economist at Standard Chartered Plc in New York, wrote today in a research note.

March’s vote to lower the benchmark rate was the five-member board’s first split decision since it began publishing minutes from monetary policy meetings in February 2011. One board member dissented, saying lower interest rates could threaten the inflation target.

Core Inflation

Speaking to the Mexican Senate on April 10 in Mexico City, Carstens highlighted policy makers’ success in containing core inflation, which excludes more volatile energy and agricultural prices.

Core inflation fell within the central bank’s target range three months after Carstens became governor in January 2010 and reached 2.88 percent in January, the lowest annual pace in at least 30 years. At an event in Acapulco last night, Carstens said that Mexico shouldn’t underestimate the problem of a potential reversal in capital flows, which could affect financial stability and economic activity.

Core inflation will be less than 3 percent for most of 2013 and 2014, the central bank predicted in today’s statement.

Annual inflation probably peaked in April and will slow to 3.7 percent in December, and core inflation is likely to remain near 3 percent in coming months, economists including Arturo Vieyra at Citigroup Inc.’s Banamex unit said in an April 24 research note. Banco de Mexico is unlikely to adjust rates, said Marco Oviedo, an economist at Barclays Plc.

‘Compatible’ View

“In terms of monetary policy, we do not expect a reaction from the central bank, as the source of the deviation from the target is supply shocks, which are very difficult to control with monetary policy,” Oviedo said in an April 24 note to clients.

The central bank’s board said in the minutes of its March 8 meeting that the rate reduction “is compatible with an expansion of spending in the economy in keeping with its potential growth and with a convergence of inflation on the 3 percent target.”

Mexico’s economy has continued to show signs of slowing, with retail sales surprising analysts in February by contracting for the second time in three months. Mexico’s gross domestic product will expand 3.5 percent this year, down from 3.9 percent in 2012, according to the median estimate of economists surveyed by Bloomberg. U.S. GDP growth this year will ease to 2 percent from 2.2 percent last year, according to a separate Bloomberg survey.

Mexican economists raised their estimates for year-end inflation to 3.89 percent on April 22 from 3.85 percent two weeks earlier, according to the median estimate in a survey by Citigroup Inc.’s Banamex unit.

Banco de Mexico will keep the 4 percent rate unchanged until January 2015, according to the median estimate in the poll, and their next move is seen as a quarter-point increase.

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