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Mexico's central bank unexpectedly raised its benchmark interest rate, ignoring suggestions by President Felipe Calderon that borrowing costs were too high.

The decision to raise the rate a quarter percentage point to 7.75 percent signals the bank doubts Calderon's measures to freeze some food prices will do enough to reduce prices. Mexico joins Chile, Brazil, Vietnam, Turkey and banks around the world in raising rates to fight inflation driven by food and energy.

“They have to be on the inflation case,'' said Alberto Ramos, senior economist for Latin America at Goldman Sachs Group Inc. “Now they have to concentrate on the fuel and food supply shocks that have intensified.''

Banco de Mexico's five-member board surprised analysts surveyed by Bloomberg. Only eight of 26 economists forecast a rate increase, while the rest predicted rates wouldn't change.

Mexico's peso strengthened to a five-year high, climbing 0.3 percent to 10.2794 per dollar. Bonds rose as investors gained confidence that the central bank will manage to curb inflation, helping preserve the value of debt's fixed payments.

Calderon urged the central bank on June 4 to take into account the spread, or difference, in benchmark interest rates between Mexico and the U.S. when setting monetary policy and said he hoped businesses can have access to “cheap credit.'' Higher relative rates can strengthen the peso, hurting exporters such as auto-parts factories and the manufacturing centers on the country's border with the U.S.

Calderon Price Accord

Domestic prices for some goods are likely to rise to reflect international prices, the bank said in a statement, even as industry groups agreed with Calderon this week to freeze prices of 160 food items including canned tuna, tortillas and juices. The president said the accord would fight inflation and ensure Mexico's poorest families can afford food.

By pressuring the central bank and helping freeze food prices, Calderon is balancing economic management with heading off a potential challenge from the left in 2009 congressional elections, said Francisco Gonzalez, professor of Latin American studies at Johns Hopkins University in Washington.

“Calderon is first and foremost a shrewd politician,'' Gonzalez said. “He wants to make things better for the average voter.''

Calderon has also tried to fight higher food prices by removing import tariffs on corn, wheat, rice and beans in May. He eliminated import taxes on nitrogen-based fertilizer, and cut in half the tax on imported powdered milk.

“The recent inflation dynamic is worrying,'' the bank said in a statement on its Web site. “The balance of risks for inflation has worsened.''

Inflation Rate

Mexican consumer prices rose 4.95 percent last month from a year earlier, the most since December 2004, driven by food, housing and air transportation costs online payday loan. The bank forecasts inflation of 4.5 percent to 5 percent in the second and third quarters, as high as 4.75 percent in the fourth quarter and as much as 4.25 percent in the first quarter of 2009.

Banco de Mexico's decision follows similar moves by other central banks in Latin America and elsewhere. Brazil raised rates by half a percentage point at each of its past two meetings and Colombia has held its rate at a six-year high to fight inflation, ignoring calls by President Alvaro Uribe for a cut.

Chile's central bank raised its benchmark interest rate more than economists forecast on June 10 to help contain the fastest inflation in more than 13 years. Vietnam, Philippines, Indonesia, China and Turkey have also raised in the past month.

Rate Outlook

Banco de Mexico may raise the key lending rate again by a quarter percentage point toward the end of its summer if inflation continues to exceed forecasts, Rafael de la Fuente, senior economist for Latin America at BNP Paribas in New York, said in an e-mailed report. De la Fuente correctly forecast the rate increase today.

“Did they explicitly bless the idea of another rate hike? No,'' said Gray Newman, chief Latin America economist at Morgan Stanley in New York, who also predicted today's decision. “But they certainly aren't ruling it out either.''

The central bank is likely to increase its inflation forecast again after it already raised its projection less than two months ago, Newman said.

Mexico's benchmark Bolsa index extended losses, falling as much as 2.2 percent to 29,179.76 when the rate increase was announced. Stocks recovered, remaining 0.6 percent lower for the day at 29,668.94 as of 1:26 p.m. in New York.

The bank said in its statement that it expects second- quarter economic growth similar to the first quarter, when the economy expanded 2.6 percent. It also said the risk of lower growth continued as the U.S. economy slows.

Inflation Expectations

The higher rates will help anchor inflation expectations and help reduce long-term interest rates, Deputy Finance Minister Alejandro Werner said today in Mexico City. He said that the government respects the bank's independence.

Julio Garcia, head of investment banking for Banco Bilbao Vizcaya Argentaria's Mexico unit, said the bank's decision wasn't a response to Calderon's hints that rates were already too high.

“It's the governor of the Bank of Mexico doing his job,'' Garcia said in an interview. “It shows the independence of the Banco de Mexico and its concern for the inflation situation.''

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