Mexico's central bank held its benchmark target for the overnight interbank rate steady at 4.0 percent, as expected, saying this stance is consistent with slower growth in the first months of this year, a fragile global environment and the stable outlook for inflation.
But The Bank of Mexico, which cut its rate in March for the first time since July 2009, said downside economic risks had risen following the depreciation of the peso and the rise in domestic interest rates, "primarily in response to the expectation of changes in U.S. monetary policy."
"Even if there is a recovery of economic activity in the second half of the year driven by U.S. industrial performance, the downside risks to economic activity in Mexico has intensified," the central bank said after a meeting of its governing board.
Last week Mexico's currency, along with other emerging markets, fell in response to fears that the U.S. Federal Reserve would soon start to wind down its asset purchases.
Although liquidity in international markets is expected to remain abundant, the central bank said possible changes in U.S. monetary policy is likely to lead to further exchange rate volatility but Mexico's strong economic fundamentals would influence exchange rates in the medium term.
The central bank said recent data point to continued growth in the United States but this has lead to uncertainty over when the purchase of assets would be reduced, triggering a significant rise in interest rates and "turbulence in international finance, particularly in emerging economies."
There are still significant downside risks to global economic growth and lower raw materials prices, along with more moderate growth in emerging economies, is expected to reduce the inflationary outlook in most countries.
Mexico's economy slowed down in the first quarter with Gross Domestic Product up by 0.45 percent from the fourth quarter. Although this was much better than expected, on an annual basis growth was only 0.8 percent, the weakest since the 2009 recession, due to weak external demand.
The central bank, known as Banxico, said recent information shows that some parts of domestic demand have reduced their rate of expansion and it does not expect any pressure from overall demand on inflation in the foreseeable future.
Mexico's inflation rate in May was 4.63 percent, marginally lower than April's 4.65 and still sharply above the central bank's 3.0 percent target.
But the central bank said that the recent rise in headline inflation was due to temporary factors and inflation is expected to ease slightly in June and "intensify the downward trend from July to settle at the third and fourth quarters between 3 and 4 per percent."
Meanwhile, Mexico's core inflation rate has remained below 3 percent for several months, suggesting convergence toward the bank's target.
"By 2014 it is anticipated that the annual headline inflation locate close to 3 percent. Meanwhile, it is estimated that annual core inflation will remain even below that level in most of 2013 and 2014," the central bank said.
Looking ahead, the central bank said it would "continue to monitor developments in all the factors that could affect inflation" and keep an eye on any second-round effects of recent price changes to "be able to respond, if necessary, to achieve the inflation target."
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