Mexico Keeps Key Rate Unchanged, Calls CPI Shock Transitory

(Bloomberg) -- Mexico's central bank kept borrowing costs unchanged after the nation's currency rallied to a three-month high, saying that recent inflation shocks are transitory.

Banco de Mexico policy makers, led by Governor Alejandro Diaz de Leon, kept the key interest rate unchanged at 7.75 percent, a move predicted by 21 of 26 economists surveyed by Bloomberg. Five expected a quarter-point increase.

The Mexican peso posted the best performance in the world in July as concern eased over the election of leftist Andres Manuel Lopez Obrador as president and optimism mounted over Nafta trade negotiations with the U.S. While central banks across the globe are inching toward tighter policy after years of extraordinary stimulus, the Federal Reserve kept rates unchanged Wednesday, and Mexican inflation that exceeded expectations has been largely due to rising gasoline and agricultural prices, which are often volatile.

"They're not overreacting to the recent developments, particularly on the inflation front," said Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc. "The outlook for growth this year is still below trend. The policy rate is already restrictive. At this stage, tightening was not necessarily warranted."

In the statement accompanying their decision, policy makers said the balance of growth risks is biased toward the downside, and the expansion this year probably will be closer to 2 percent than 3 percent. The bank said it expects core inflation to continue its slowing trend, although the risk of more pressure from energy and food prices persists. The board will adjust its policy in a timely and robust manner to ensure that inflation reaches its 3 percent goal and expectations are anchored, they said.

In keeping the rate on hold, the central bank looked past inflation that has quickened more than economists expected over the past two months. The annual rate climbed to 4.85 percent in the first half of July, up from a 16-month low of 4.41 percent in the second half of April.

The peso rallied 6.8 percent in July to levels stronger than 18.5 per dollar. Its tumble in May and the first half of June ahead of the election had helped spur the central bank to raise the key rate to its current level at its June 21 meeting. Mexico's peso maintained its loss after the decision, falling 0.4 percent to 18.6571 per dollar in Thursday afternoon trading.

Since Lopez Obrador's victory on July 1, many on his transition team, including chief of staff Alfonso Romo, have worked to dispel Wall Street's worst fears about the leftist, and the policies he may pursue. Lopez Obrador himself has struck a conciliatory tone with the business community, helping spur the peso's rally.

More recently, the currency has strengthened on signals that Mexico and the U.S. are pushing for a deal for the North American Free Trade Agreement this month.

"Banco de Mexico is seeing that the risks of Nafta and the election have decreased considerably in recent weeks," Enrique Covarrubias, the chief economist at Actinver, said in an e-mailed response to questions. "The tone seems to me to be ‘cautiously optimistic.'"

--With assistance from Rafael Gayol and Daniela Guzman.

To contact the reporter on this story: Eric Martin in Mexico City at emartin21@bloomberg.net

To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Robert Jameson, Philip Sanders

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