May 18, 2017 / 6:52 PM / a year ago

UPDATE 2-Mexico central bank unexpectedly hikes rates; door open to further hikes

(Recasts with more tightening possible; adds central bank and analyst’s comments, background)

MEXICO CITY, May 18 (Reuters) - Mexico’s central bank unexpectedly hiked its key interest rate on Thursday as it sought to keep in check inflation that remains above its target, providing little evidence the tightening cycle was over and prompting the peso to briefly reverse losses.

Banco de Mexico’s governing board unanimously decided to increase the benchmark rate by 25 basis points, to 6.75 percent, its highest level since March 2009, surprising most market participants who expected the bank would hold rates steady.

The bank said in a statement after its monetary policy meeting that it hiked the rate in order to “avoid contagion in the process of price formation, anchor inflation expectations” and help inflation converge to its target.

Annual inflation is running at its fastest pace in nearly eight years, well above both the bank’s 3 percent target and its 4 percent tolerance level, as consumer prices rose 5.82 percent in the year through April.

Banco de Mexico said it expected inflation to remain above the target range during 2017 and to start converging toward its 3 percent target by year-end and during 2018, leaving the door open to new rate hikes.

“The governing board will closely follow the evolution of the determinants of inflation and its medium- and long-term expectations. ... It will also keep an eye on the evolution of the relative monetary position between Mexico and the United States,” the statement said.

“This, in order to be able to continue taking the necessary measures to achieve the efficient convergence of inflation to the 3.0 percent target,” it added.

While 17 of 25 analysts and economists surveyed in a Reuters poll had expected the central bank to keep the rate steady at 6.5 percent, a minority had forecast a rate increase.

Speaking at an event in Washington in April, Banco de Mexico chief Agustin Carstens hinted that the cycle of monetary tightening might not be over, saying there were “still some issues that need to be taken care of.”

“Banxico seems to think it has more work to do,” said Neil Shearing, chief emerging markets economist at Capital Economics. “We’re comfortable with our forecast for one final 25bp hike in the policy rate to 7.0 percent in this cycle.” (Reporting by Mexico City newsroom; Writing by Anthony Esposito; Editing by Jeffrey Benkoe and Leslie Adler)

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