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Tortillas Spark Inflation, Drive Down Mexico's Peso (Update1)

By Valerie Rota

March 5 (Bloomberg) -- An increase in the cost of tortillas, a staple of the Mexican diet since the Maya ruled 1,000 years ago, has triggered a slump in the peso.

Tortilla prices jumped 5.9 percent in January, the most in eight years, after costs climbed for corn, the main ingredient. That increase fanned inflation and a bond market rout that curbed demand for the currency. The peso has fallen 2.4 percent in the past month, making it the world's third-worst performer against the dollar among the 70 currencies tracked by Bloomberg.

``There's a big risk that tortilla price increases will lead to higher wage demands and fuel inflation,'' said Eduardo Perez, head bond trader at Mexico City-based brokerage Valores Mexicanos SA, the country's largest independent brokerage. ``Foreign investors don't like this environment and are selling. This is directly linked to peso weakness.''

The currency's slide in the past month to 11.1820 pesos per dollar leaves it down 3.3 percent in 2007. Only the South African rand and the Turkish Lira have fallen against the dollar more in the past month, weakening 3.24 percent and 3.2 percent, respectively.

A slowdown in the U.S. economy has added to the peso's drop by curbing demand for exports and cutting into remittances immigrant workers send to their families. Mexicans living abroad sent an average of almost $2 billion a month home last year.

The peso may fall further in the next several months as corn prices continue to rise. Corn has soared 15 percent in the past eight weeks and 119 percent since late 2005 as demand for the grain grows from ethanol producers.

Tortilla Pact

President Felipe Calderon, seeking to shore up support for his administration less than two months after taking office, arranged a price freeze with tortilla makers on Jan. 18. The rise in corn may lead to price increases at tortillerias, as small tortilla shops are known, once the government accord ends next month. Higher corn prices are also driving up the cost of livestock feed, eggs, chicken and beef.

``Risks for the peso will begin at the end of April or beginning of May when the pact ends, inflation pressures begin to mount and demand for bonds drops,'' said Luis Raul Rodriguez, head economist at Vector Casa de Bolsa SA, a brokerage in Mexico City. ``It'll be a dangerous moment.''

Under the agreement, tortilla shops agreed to hold prices at a maximum of 8.5 pesos ($0.76) a kilogram, down about 2.5 pesos from the highest prices at the time.

Calderon also dispatched 380 consumer protection agency officials to crack down on cheating and record prices at shops throughout the country. The agency began publishing those prices on its Web site to try to foster competition. They report on about 180 shops in Mexico City alone.

Enchiladas, Quesadillas

``We need citizens to call and complain and report tortilla shops that are exploiting the situation,'' Gladis Lopez, head of the agency's enforcement department, said in an interview in Mexico City. ``We're getting there.''

Historians track the tortilla back about 1,000 years, when the Mayans controlled much of present-day southern Mexico from their base in the Yucatan peninsula. A flat bread made out of ground corn, quicklime and water, the tortilla is served at breakfast, lunch and dinner in many Mexican households. It's featured in some of the country's most famous dishes including tacos, enchiladas, quesadillas and flautas.

The tortilla accounts for almost half of the calories the average Mexican consumes each day. Lula Martin del Campo, head chef at HSBC Holdings Plc in Mexico City, said there's no food that has similar importance in the U.S. diet.

``The majority of poor Mexicans use tortillas as their forks and knives,'' Martin del Campo said.

Core Inflation

Calderon's measures pushed down tortilla prices 1.3 percent in the first half of February after they rose 8.8 percent in the previous two months.

The drop slowed a surge in the core inflation rate, the price gauge most closely watched by analysts in Latin America's second-biggest economy. The annual core rate, which excludes energy and some fresh foods, was 3.95 percent in the 12 months through mid-February, the highest rate since August 2002. The core rate was 3.89 percent in January.

Mexico's overall inflation rate rose to 4.1 percent in the 12 months through mid-February, above the central bank's target range of 2 percent to 4 percent.

Central bankers said after a policy meeting on Feb. 23 that they would lift the country's benchmark lending rate from 7 percent, a 2 1/2-year low, should core inflation fail to slow. They also said they were concerned that rising tortilla prices would ``contaminate'' inflation expectations and lead workers to demand bigger pay increases.

Bond Market Rout

Banco de Mexico's statement deepened declines in the currency and bond markets. Peso-denominated bonds have lost 4 percent this year, the worst performance among local currency- denominated securities issued by emerging-market countries, according to JPMorgan Chase & Co. data.

The yield on the government's 8 percent peso bonds due 2015 has risen 46 basis points, or 0.46 percentage point, since Dec. 21 to 7.9 percent, according to Santander Central Hispano SA. The bond's price, which moves inversely to the yield, has dropped 3.05 centavos to 100.61 centavos per peso.

Vector's Rodriguez began reading in December the daily reports on tortilla prices published by the consumer protection agency. Now, confident the government-brokered accord will hold down prices through next month, he's shifted his focus to international corn prices.

``The expected success of the pact is based on the assumption that the corn price impact would be short-lived,'' Rodriguez said. ``This is not the case anymore. We're expecting inflation to surge.''

To contact the reporter on this story: Valerie Rota in Mexico City at vrota1@bloomberg.net .

Last Updated: March 5, 2007 13:31 EST