Bloomberg.com: Mexico Central Bank Holds Lending Rate at 7 Percent (Update3)

Mexico Central Bank Holds Lending Rate at 7 Percent (Update3)

By Patrick Harrington

Jan. 26 (Bloomberg) -- Mexico's central bank kept its lending rate unchanged today and signaled it's prepared to lift borrowing costs after missing its 2006 annual inflation target.

Banco de Mexico held its overnight rate at 7 percent, matching forecasts from all 15 economists surveyed by Bloomberg. The bank has left the rate at 7 percent since May, halting cuts that brought it down from 9.75 percent last year.

A surge in the price of tortillas, a Mexican staple, and other food items, pushed consumer price increases above the central bank's 2 percent to 4 percent target last year. That, in addition to rising core inflation, has some economists, such as Barclays Capital Inc.'s Michael Hood, expecting the central bank will be forced to raise rates as early as next month.

``The board will be attentive to the evolution of other prices and services,'' policy makers wrote in their statement. ``If the supply shocks have a negative effect on these variables, the board will consequently adjust its monetary policy in order to keep inflation within the target.''

Consumer prices rose 4.05 percent in 2006, according to the central bank. Core inflation, which excludes fresh food and energy, was 3.6 percent in 2006, up from a record low of 2.9 percent in the 12 months ended in February.

Tortilla, Sugar

Central bankers said rising tortilla and sugar prices had caused two-thirds of the rise in core inflation in 2006. Because that surge is limited to a few products, they said, it should not ``contaminate'' other prices and wages.

As a result, both general and core inflation should end this year between 3.5 percent and 4 percent, down from between 4 percent and 4.5 percent for general inflation in the first quarter, the bank said.

The language used in today's statement marks a shift from previous months, Hood said in a phone interview from New York.

``It takes on board the reality that the world is different from what they were expecting it to be back in November,'' he said. ``They are very clearly saying that if there is a move it's going to be up and not down.''

The central bank is indicating it will not react to the transitory price shocks unless they spread to non-food prices, wages or boost inflation expectations, said Rafael de la Fuente, Chief Latin America Economist at BNP Paribas in New York.

``If those get contaminated, then it will be a different ballgame,'' he said in a telephone interview.

`Pre-Emptive'

In reports last week, Merrill Lynch & Co. predicted the central bank will put off interest-rate cuts and JPMorgan Chase & Co. said policy makers may raise rates next month to restrain inflation.

JPMorgan economist Alfredo Thorne, who is based in Mexico City, expects Banco de Mexico to use a ``pre-emptive'' rate increase to bring the overnight lending rate to 7.25 percent at its Feb. 23 meeting. Thorne previously forecast the bank would leave borrowing costs unchanged at 7 percent through this year.

Mexico's President Felipe Calderon last week reached an agreement with companies and distributors to cap tortillas at 8.5 pesos ($0.78) a kilogram to staunch rising prices. Tortilla prices had risen to about 11 pesos a kilogram in the first half of January from 6 pesos last year.

``It's a serious short-term problem,'' Calderon said at a news conference today from Davos. ``We are fighting with all the instruments we have to make sure that surge does not affect the popular economy.'' Mexico is working to ensure corn growers in Mexico have ``everything they need'' to raise output, he said.

`No Hurry'

Despite the language used in Banco de Mexico's statement, economists such as de la Fuente, Goldman Sachs Group Inc.'s Paulo Leme, ING Groep's Salvador Moreno and Lehman Brothers Inc.'s John Welch still expect rate cuts this year.

De la Fuente expects central bankers to lower the overnight lending rate to 6.50 percent by the year-end. Leme, who said in a phone interview before the statement that recent comments by central bank Governor Guillermo Ortiz had been misconstrued as ``extremely hawkish,'' expects the bank to cut the overnight lending rate to 6.25 percent in 2007.

``They are in no hurry to hike rates,'' Gray Newman, chief Latin America economist with Morgan Stanley, said in a phone interview from London. ``They clearly are saying that if what is a localized issue begins to broaden and affect wages and inflation expectations then they will respond, but we have always known that.''

To contact the reporter on this story: Patrick Harrington in Mexico City at pharrington8@bloomberg.net

Last Updated: January 26, 2007 14:55 EST