(Adds quote from Central Bank governor on Fed)
By Michael O‘Boyle and Alexandra Alper
MEXICO CITY, Dec 17 (Reuters) - Mexico’s central bank hiked borrowing costs on Thursday for the first time in seven years in a bid to stem further weakening in the peso after the Federal Reserve lifted U.S. interest rates the day before.
The Banco de Mexico raised its benchmark interest rate 25 basis points to 3.25 percent from a record low, as expected by 19 of 25 analysts surveyed by Reuters this week.
The central bank said it was raising interest rates even though inflation was at a record low because the Fed had hiked by a quarter percentage point.
Mexican policymakers said they were concerned that if they had not moved there might have been a “disordered” depreciation in the peso that could have affected inflation expectations.
Mexico’s peso pared losses after the announcement to break past the key 17 per dollar level and trade nearly flat around 16.99 per dollar.
Central Bank Governor Agustin Carstens told Reuters last week that Banxico must be ready to “take care” of the peso by raising interest rates in order to prevent foreign investors from dumping local-currency government debt.
A few hours after the decision, Carstens told local radio the bank would be monitoring the U.S. central bank closely.
“We think in the short term it really is very important that we’re very vigilant on the Fed’s actions because of the market turbulence here, because of the volatility in capital flows, and what we want to avoid is a destabilizing scenario in our economy,” he said.
Even as other emerging markets have seen outflows this year, foreign holdings of about 2.07 trillion Mexican pesos ($122 billion) have held relatively steady, near record highs.
Alonso Cervera, an economist at Credit Suisse in Mexico City, said the bank’s statement suggested Mexico could continue to match further Fed moves.
“If they had not moved, I think it would have been a disaster for the peso,” he said.
The peso has lost around 13 percent against the dollar this year, hammered by fears a U.S. rate increase would drive investors to dump risky emerging market assets. Worries about the dramatic fall in oil prices, which underpin Mexican government spending, have also weighed.
The central bank said in its statement that inflation would rise back toward 3 percent next year after ending 2015 around 2 percent.
Mexico’s annual inflation cooled to its seventh consecutive record low in November, marking the longest period ever in which the pace of consumer price gains stayed below the central bank’s 3 percent target.
The Mexican economy grew faster than expected in the third quarter, and the central bank said on Thursday that slack in the labor market and the overall economy appeared to be gradually diminishing. ($1 = 16.9810 Mexican pesos) (Additional reporting by Jean Luis Arce and Dave Graham; Editing by Chizu Nomiyama and Lisa Shumaker)