Mexico's Central Bank Raises Rates as Inflation Concerns Mount -- Update

The Bank of Mexico raised interest rates by a quarter percentage point Thursday after a six-month pause, as policy makers have grown increasingly worried about high inflation.

The overnight interest rate target now stands at 7.25% -- the highest since February 2009.

The policy meeting marked Alejandro Díaz de León's first as the central bank's governor. He took over two weeks ago facing a tough situation, with high inflation, slowing economic growth, and a weak and volatile peso.

Some analysts said Mr. Díaz de León may have sought to burnish the bank's orthodox credentials at his first meeting as governor.

"The main challenge for the bank's board...is to reinforce the downward path for inflation to the target," the policy statement said. A majority of the bank's four voting members agreed to the move, while one member called for a half-percentage point increase, underscoring the concern inflation is causing for the board.

The peso -- the second most traded emerging-market currency with daily average turnover of some $112 billion -- appreciated 0.3% just after the policy announcement, briefly hitting 18.97 to the U.S. dollar before moving back above 19.

The rate decision was increasingly expected by markets and analysts in recent weeks as annual inflation came in above expectations in November at 6.6%, more than double the bank's 3% target.

The Bank of Mexico had been expecting inflation to start slowing at the end of the year, but now sees it ending December above the November level.

In its policy statement, the central bank said the outlook for inflation has turned "more complex" and that it will take longer for prices to return to the target. The bank now sees inflation "moderately" above 3% during the next two years.

The rate increase is probably the last in the cycle, said Neil Shearing, the chief emerging markets economist at Capital Economics. "But it's clear that policy makers won't require much persuading to tighten again, particularly if the peso comes under renewed pressure."

The U.S. Federal Reserve's rate increase this week also left Mexico's central bank little maneuvering room. The bank said the peso has been pressured since the third quarter by expectations of Fed rate increases and uncertainty over the renegotiation of the North American Free Trade Agreement with the U.S. and Canada.

Higher borrowing costs mean less money available for consumers, which in turn puts downward pressure on prices. Many observers fear that also will be a drag on an already sluggish Mexican economy that contracted 0.3% during the third quarter after a string of natural disasters hit Mexico.

The growth outlook looks gloomy, the bank indicated, as the often contentious Nafta talks have hit investment "considerably" and are likely behind the slowdown in private consumption in the second half of the year.

Inflation was below the central bank's target until late last year. The uptick this year is mainly explained by the average 20% increase in gasoline prices ordered by the government at the beginning of the year as the country liberalizes energy markets, and peso depreciation that has made imports more expensive.

Until early this month, most analysts expected the Bank of Mexico to stand pat on rates in the near term after the central bank called a pause in a tightening cycle that increased the overnight rate to 7% from 3% between December 2015 and June 2017.

Write to Juan Montes at juan.montes@wsj.com

(END) Dow Jones Newswires

December 14, 2017 16:05 ET (21:05 GMT)