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Weak peso has Mexico central bank worried as inflation jumps

Mexico is Canada's third-largest trading partner.


Mexican inflation rose to a 1-1/2 year high in early June, underscoring central bank worries that a weak currency could push prices higher and give policymakers less room to cut interest rates as the global economy falters.

Minutes of the central bank's June meeting showed central bankers were unanimous in a decision to leave the country's key rate on hold at 4.5 per cent two weeks ago and all agreed on the need for a balanced message to communicate its neutral stance.

Slowing job growth in the United States could crimp the demand for Mexican exports that has so far helped shield Mexico from the global slowdown that has dragged on Brazil and pushed Latin America's top economy to slash borrowing costs.

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The minutes, released on Friday, showed a majority on the Banco de Mexico's board agreed the risk to Mexican growth had worsened due to uncertainty in the global economy.

But a majority also feared that a slump in the peso could drive up inflation if it remained weak for very long, pushing the board to dial back earlier suggestions that it was leaning toward an interest rate cut.

"All members of the board reiterated the importance of the Banco de Mexico sending a balanced and symmetrical message, which reflects the determination of the board to move in either direction, depending on circumstances," the minutes showed.

Investors have pulled back rate cut bets in the last two months and expect no change to benchmark credit costs, which have been unchanged since mid-2009, until at least April 2014.

Mexico's peso has slumped about 9 per cent against the dollar since mid-March on fears that Europe's debt crisis could set off another global financial meltdown.

Higher import prices could add more fuel to price increases. Data on Friday showed that inflation accelerated in early June to 4.30 per cent, its highest rate since late 2010, piercing the central bank's ceiling of 4 per cent for acceptable price increases.

Higher headline inflation makes lower rates less likely, though economists also doubted policymakers would move to raise borrowing costs and potentially exacerbate the risks to growth.

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"I have problems seeing that if even they do get first round or even second round (inflation) effects from the weak currency, that we would see the central bank raising rates in this environment - I would be shocked," said UBS economist Rafael de la Fuente.

Hike unlikely

Most central bank board members were concerned that even though there had not been a big impact on inflation from peso depreciation until now, this could change if the peso remained weak, the minutes showed.

But some argued that the exchange rate effect was temporary and so far there were no signs of second round effects.

A 4.73 per cent rise in core merchandise prices during the year to early June, compared to a 4.01 per cent rise through early May, likely reflected some pass-through from the peso.

Still, volatile fruit and vegetable prices are the main factor driving the headline inflation rate higher and economists said policymakers are not likely to react to such temporary pressures.

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Core services prices fell 0.03 per cent in early June, highlighting the lack of inflation pressure coming from the domestic economy, where central bankers noted there was still a degree of slack and unused capacity.

So far this year, Mexican growth is holding up as the country looks likely to grow faster than its regional rival Brazil for the second year in a row.

But Brazil's aggressive campaign to cut interest rates could jump-start its economy in the second half of the year while weaker U.S. growth drags on Mexico, economists at Bank of America-Merrill Lynch wrote in a note.

Mexico's jobless rate fell slightly in May to a seasonally adjusted 4.97 per cent, another data report showed on Friday, as solid exports likely continued to support new hiring.

Earlier this week, central bank governor Agustin Carstens said global volatility could keep the peso pressured for more than a year, though in another interview he noted Mexico could still grow nearly 4 per cent this year if a U.S. slowdown reverses.

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