Mexico Bank May Reduce Rate for Second Month to Revive Economy

By Jens Erik Gould

Feb. 20 (Bloomberg) -- Mexico’s central bank will probably reduce its benchmark interest rate for the second consecutive month in a bid to revive a flagging economy.

The bank’s five-member board, led by Governor Guillermo Ortiz, will cut the lending rate a half percentage point to 7.25 percent, according to 17 of 23 economists surveyed by Bloomberg. Four analysts expect a quarter-point cut, one predicted the bank would keep the rate unchanged and another sees a full-point cut.

The bank will cut the rate to a 16-month low after inflation slowed in January and government estimates showed Latin America’s second-biggest economy probably shrank in the last quarter, making the effort to spur growth a more immediate priority than keeping prices in check, said Sergio Luna Martinez, head of economic research at Citigroup’s Banamex unit in Mexico City.

“Prices aren’t the problem -- it’s that no one is buying things in the world,” Luna Martinez, who forecasts a half-point cut, said about the drop in Mexican exports. “The internal market has slowed down faster than we expected.”

Mexico has released reports in recent weeks that signal a weakening economy. Industrial production fell by the most in almost seven years in December, auto production dropped 51 percent in January, and consumer confidence sank to a record low last month. The central bank lowered its economic forecasts last month, saying gross domestic product may contract as much as 1.8 percent this year because of the global financial crisis.

Mexican factories are scaling back production amid a slowing economy and declining exports to the U.S., the destination for 80 percent of Mexico’s $292 billion in sales abroad. December exports to the U.S. dropped 19 percent from a year ago.

Stimulus Package

Lower interest rates can help prompt businesses to invest and consumers to buy on credit. Cheaper loans also can spur inflation by strengthening demand. The bank last month reduced the key lending rate for the first time in almost three years, lowering it a half point to 7.75 percent. A half-point cut today will push the overnight rate to the lowest since October 2007.

On Jan. 7, President Felipe Calderon announced an economic stimulus package that lowered energy prices, expanded unemployment benefits and increased infrastructure spending.

Policy makers may be hesitant to cut rates a half point because they don’t want to further weaken the peso, said Ricardo Aguilar, an economist with the Mexico City brokerage firm Invex Casa de Bolsa SA.

The currency has slumped about 30 percent in the past six months, the second-worst performance among the 16 most-traded currencies tracked by Bloomberg.

Currency Stability

“The main task of the central bank is to control the stability of the currency,” said Aguilar, who forecasts a quarter-point cut. “They shouldn’t lower the rate as aggressively as they did in January.”

The central bank has stepped up its intervention in the currency market in a bid to boost the peso. The currency fell to a record low because the deepening recession in the U.S. dried up dollar flows from exports, remittances, tourism and foreign direct investment. Ortiz said Feb. 11 that the bank will continue to intervene in the market for the “foreseeable future.”

Still, a depreciated peso is unlikely to drive manufacturers and retailers to raise prices significantly because consumer demand is weak, making it easier for policy makers to lower the key lending rate without fanning inflation, Luna Martinez said.

Annual inflation slowed to 6.3 percent last month and probably peaked in December, the bank said last month. Ortiz said Feb. 11 that inflation will be in line with the bank’s forecasts. The bank predicts inflation will be no more than 6.25 percent in the first quarter and no more than 5.75 percent in the second quarter.

“The economy is contracting very fast -- we’re in an outright recession in Mexico,” said Rodrigo Valdes, a Latin America economist with Barclays Capital Inc. in New York. “Lower expectations for inflation allow policy to limit the extent of this falling economic output.”

To contact the reporter on this story: Jens Erik Gould in Mexico City at jgould9@bloomberg.net