UPDATE 2-Mexico Oct inflation cools; rate hike still seen

MEXICO CITY, Nov 9 (Reuters) - Mexican inflation slowed sharply in October due to lower vegetable prices and a weak economy, but the central bank is still expected to raise interest rates to counter the impact of higher taxes. Mexican consumer prices rose 4.5 percent in the year through October, the central bank said on Monday. That was down from 4.89 percent in September and the lowest level since March 2008. The central bank spent most of this year cutting interest rates to fight the country's worst recession since the 1930s, but in recent months has warned that higher taxes could fuel inflation. "The central bank has its eye on taxes," said Rafael Camarena, an economist at Santander in Mexico City who thinks policymakers will raise rates in both February and March. Mexico's Congress recently passed a series of tax increases that will take effect next year. The central bank has also said an economic recovery will also be a factor in future interest rate decisions. Mexico's economy is expected to shrink nearly 7 percent this year because of a drop in U.S. demand for its exports, though the central bank predicts that growth resumed in the third quarter. The economic slowdown has cooled inflation because higher unemployment and weaker spending gives companies less leverage to raise prices. Most investors think the central bank's next move will be to raise interest rates. In a sign that they did not shift their bets, yields on rate futures were unchanged after the data. Analysts had expected a slighter drop in the annual rate. Prices rose 0.30 percent in October from the previous month, while the median expectation in a Reuters poll was for a rise of 0.44 percent. Prices fell for tomatoes, avocado and oranges in October. The closely watched core consumer price index, which strips out some volatile food and energy prices, rose 0.29 percent in October. In September, headline consumer prices rose 0.50 percent, while core prices climbed 0.43 percent. (Editing by Chizu Nomiyama) Keywords: MEXICO ECONOMY/ ([e-mail]; Tel: [phone]; Reuters Messaging: [e-mail]) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved.

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