Mexico central bank faces 'complex environment': Diaz de Leon

By Michael O'Boyle and Ana Isabel Martinez

MEXICO CITY (Reuters) - Mexico's central bank faces difficult decisions as it balances a spike in inflation against an expected economic slowdown, Deputy Governor Alejandro Diaz de Leon said on Monday.

"We are in an especially complex environment," Diaz de Leon told Reuters in an interview.

Diaz de Leon pointed to the heightened risk of inflation from a weak peso and a hike in gasoline prices as well as the threat to Mexican growth from uncertainty about the impact of U.S. President Donald Trump's policies on Mexico's economy.

Mexico's peso hit a record low of around 22 per dollar just before Trump's inauguration in January because of threats to impose tariffs on Mexican-made goods.

The peso gained back some ground when Trump did not immediately move to withdraw from the North American Free Trade Agreement between the United States, Mexico and Canada. Some analysts say the market is betting that a renegotiation of NAFTA may not hit Mexico's exports as hard as feared.

"It is very premature to say what type of scenario is incorporated in the exchange rate," Diaz de Leon said.

A Reuters poll of economists this month found Diaz de Leon was considered the most likely to replace outgoing central bank chief Agustin Carstens.

Carstens said in December that he would resign at the end of June to take the top post at the Bank for International Settlements in October.

But Carstens is now set to continue in his post until the end of November after President Enrique Pena Nieto asked him to stay on, a spokesman for the president said earlier on Monday.

Mexico's central bank has raised its benchmark interest rate by 325 basis points since December 2015, hiking five times in 50-basis point steps last year as the peso sank.

The Banco de Mexico hiked by a half-percentage point again earlier this month, taking its main rate to 6.25 percent, after a 14 percent hike in regular gasoline prices drove the annual inflation rate to 4.72 percent, its highest in more than four years.

Mexico's central bank targets an inflation rate of 3 percent, plus or minus one percentage point.

"What we are seeking is that inflation expectations in the medium and long term will remain close to the inflation target," Diaz de Leon said.

Yields on Mexican interest rate swaps suggests investors expect the central bank could hike its main rate by at least 100 basis points more this year.

Diaz de Leon was cautious in discussing the bank's next move. He stuck to the language in the central bank's statement from its last hike, repeating that the bank will monitor how the peso and gasoline prices are affecting inflation, while also watching monetary policy in the United States as well as slack in the Mexican economy.

Diaz de Leon said it was "very difficult" to say which of those factors could drive further interest rate changes.

"It is going to depend on what type of adjustment is seen both in the process of price formation and in these other factors," he said.

Diaz de Leon said a slowdown in growth could make it less probable the economy would experience widespread inflation.

"It is very important to continue to evaluate in what part of the (economic) cycle the Mexican economy is," he said.

Mexico's gross domestic product growth is expected to slow to around 1.5 percent this year from 2.3 percent last year.

(Reporting by Michael O'Boyle and Ana Isabel Martinez; Editing by Eric Meijer)