Mexico will protect peso, Fed not only factor for rates: Carstens

MEXICO CITY (Reuters) - Mexico must be ready to "take care" of the battered peso as a U.S. rate hike looms, but U.S. Federal Reserve policy will not be the only factor driving Mexico's rate decisions, Central Bank Governor Agustin Carstens said on Monday.

Carstens leads the Bank of Mexico's five-man board, which is expected to raise its benchmark interest rate from 3 percent next week, when the Federal Reserve is seen tightening borrowing costs for the first time in nearly a decade.

Policymakers in Latin America's No. 2 economy are expected to hike, even though inflation in Mexico is at a record low, in order to prevent a stampede for the exits by foreign investors, who could dump peso bonds for U.S. Treasuries as yields rise.

In an interview with Reuters, Carstens explained his recent statement that Mexico's response will not be "automatic" to any move by the Fed.

"What we want to say is that the actions of the Fed are not going to be the only thing that determines monetary policy going forward for the Bank of Mexico," Carstens said, speaking in a wood-paneled salon in the central bank's office.

Carstens said policymakers were also watching inflation, which cooled to a record low of 2.27 percent in early November, as well as sluggish growth that is not seen fueling demand-side price pressures for some time.

"We are facing opposing forces," Carstens said. On one side inflation expectations are well anchored, but the peso's deep losses could still "ultimately have some impact on prices, especially for tradable goods," he added.

He said the pass through to inflation from the weak peso had been "slow" so far. However, he said the central bank needed to be ready to "take care" of Mexico's currency.

"The bank of Mexico, at some point, has to send a signal that it is worried about the value of its currency. Because this also affects the will of people to hold assets in the national currency," Carstens said.

Even as other emerging markets have seen outflows this year, foreign holdings of about 2.05 trillion Mexican pesos ($121 billion) have held relatively steady, near record highs.

Some fund managers are skeptical that one U.S. rate hike could trigger big flows out of Mexico and they are concerned that higher interest rates could hurt its economy.

"The Mexican economy is one of the strongest in emerging markets," said Andrew Stanners, a fund manager at Aberdeen Asset Management in London. "We are not at a point where fixed-income investors are going to walk."

Still, 20 of 22 economists in a poll by Banamex on Monday expect the Bank of Mexico to raise its rate by 25 basis points on Dec. 17, the day after the Fed's own rate announcement.

Mexico's peso has hit successive all time lows this year and is down nearly 13 percent against the dollar year-to-date.

The peso fell to a more than two-month low on Monday as crude oil prices hovered near 7-year lows. Mexico is a major crude producer and exporter to the United States.

The peso's tumble triggered the central bank to sell $400 million to support the currency. Carstens has said he wants to replace the peso's support from dollar auctions with higher interest rates.

Carstens said global volatility could continue to hit the peso this month. However, he said the peso would be anchored by the strong fundamentals of the Mexican economy.

While the peso may suffer due to uncertainty about the Fed, it will eventually recover ground as the U.S. economy gains strength due to the strong trade ties between the two neighbors.

"I am convinced that in the medium- and long-term, that once the (Fed) normalization begins to come to an end, that this will be very good news for Mexico," he said.

Carstens was careful not to indicate directly whether or not he is in favor of a hike at next week's policy meeting. He favors giving "data dependent" guidance on future moves, but does not want to give too much away.

"I do not think that it is optimal to be too prescriptive going forward," he said. "Because the uncertainty that exists could make a scenario, even the most plausible, not happen, and then one ends up sending the market in the wrong direction."

(Reporting by Michael O'Boyle; Editing by Simon Gardner, Bernard Orr, Diane Craft)