(Updates with details of Fed decision)
MEXICO CITY, Sept 17 (Reuters) - Mexico's peso gained on Thursday after the U.S. Federal Reserve said it would hold interest rates steady, boosting the chance the Mexican central bank will keep borrowing costs on hold next week.
The peso briefly strengthened more than 1 percent to its best level in about a month before retreating to 16.4445 per dollar, up around 0.6 percent.
The U.S. Federal Reserve kept interest rates unchanged on Thursday but left open the possibility of a modest policy tightening later this year.
Yields on short-term Mexican interest rate swaps bid lower as investors dialed back bets that Mexico could lift its benchmark interest rate off a record low of 3 percent at its next meeting on Monday.
The Fed's move "supports the peso, and in that regard gives the Central Bank of Mexico extra time to act," Alberto Ramos, an economist with Goldman Sachs, said in a telephone interview from New York.
The peso's strength in the wake of the Fed decision will give Mexican policymakers room to leave Mexican interest rates on hold at a record low to help a sluggish economy gain steam, analysts said.
The peso, the most liquid emerging market currency, has suffered this year, hitting successive record lows as investors bet higher U.S. interest rates could sap demand for riskier assets.
Mexico has been expected to raise interest rates when the Fed increases borrowing costs in order to try and prevent peso losses from deepening further and driving up consumer prices.
But policymakers have said they are facing a dilemma, since inflation is at a record low and the economy is sluggish.
Still, the Fed's move to hold rates could soon give way to renewed speculation about when U.S. policymakers could act, which could limit the peso's gains and even lead to renewed losses in the weeks to come.
"This will provoke only temporary euphoria in markets," said Jorge Gordillo, an analyst at CI Banco in Mexico City. (Reporting by Michael O'Boyle, Anna Yukhananov and Noe Torres.; Editing by Diane Craft)