Mexico inflation dealt another blow in September

By Greg Brosan
Reuters 10/07/2005

MEXICO CITY – Mexican inflation fell to a lowest recorded annual rate of 3.51 percent in September as the central bank exorcised the ghost of hyperinflation and looks set to keep cutting interest rates to spur growth.
Consumer prices rose 0.40 percent in September, below expectations. Closely watched core inflation, which strips out volatile food and energy prices, was 0.18 percent during September, the bank said on Friday. "It's a good number," said John Welch, an economist at Lehman Brothers in New York. "They were able to bring inflation down very fast."

A vigorous cycle of monetary policy tightening by Mexico's central bank last year sent foreign investors flocking to buy long-term peso-denominated debt, something unimaginable for a country once crippled by triple digit price increases.

Now the bank can concentrate on cutting rates to give an energy boost to a stable but tepid economy weighed down by lackluster manufacturing hurting from a drop in U.S. demand.

Mexico's government said on Friday gross fixed investment, a measure of spending on machinery, equipment and construction, rose 2.9 percent in July from the year-ago period, compared with a Reuters poll forecast of 5.3 percent.

PRUNING FOR GROWTH

The central bank began cutting interest rates on August 26 and has so far pushed down the country's overnight lending rate 50 basis points to 9.25 percent. Most analysts expect it to carry on snipping.

"I think that the next couple of rate cuts are pretty much a slam dunk," said Michael Gavin, chief Latin American economist at UBS.

"December may be interesting," he added. "If inflation remains contained and the economy remains weak I think you'll continue to see rate cuts in December and beyond."

After rising in an emerging market sell-off on Thursday, yields on Mexican T-bills and bonds dropped on Friday at maturities out to 20 years as investors foresaw lower inflation and sought to lock in yields ahead of more expected rate cuts.

Reducing rates facilitated access to credit, but analysts say they will eventually dull demand for local Mexican paper as yields fall, especially as inflation concerns prompt the U.S. Federal Reserve to keep raising interest rates.  "We're not at that point yet," said Gavin.

The central bank has a target range of between 2 and 4 percent inflation in 2005, and its long-term target is 3 percent. HSBC Securities said that with inflation converging on 3 percent, interest rate cuts could stretch well into next year. "As long as this process continues, we would expect the monetary-easing cycle to remain at the same pace of 25 basis points per month until April," it said. Lehman Brothers' Welch said he saw Mexico's overnight rate reaching 8.5 percent by the end of the year and ending 2006 at 7 percent.