Mexico to Start Selling Three-Year Inflation Bonds

Sept. 27 (Bloomberg) -- Mexico plans to sell three-year inflation-linked bonds for the first time since 1998 as rising food and fuel prices buoy investor demand for securities linked to the consumer price index.

Mexico plans to issue 300 million inflation units, or about 1.16 billion pesos ($106 million), of the three-year security every four weeks in the fourth quarter, according to the Finance Ministry's quarterly financing plan released today. One inflation unit, or UDI, equals about 3.86 pesos (35 cents). The government will continue offering 10-, 20- and 30-year maturities linked to the consumer price index.

``Inflation bonds are attractive given the current environment,'' said Eduardo Perez, who helps oversee about $5 billion in assets in Mexico City at Grupo Nacional Provincial SA, the country's biggest insurance company.

Average bids in sales of 10-year inflation bonds in the third quarter were two-thirds higher than the previous three months as investors anticipated the approval of a tax bill that threatened to fan inflation. Congressional passage of the tax overhaul earlier this month prompted central bankers to say last week that the inflation outlook has deteriorated.

Banco de Mexico, which kept its benchmark lending rate at 7.25 percent at its Sept. 21 meeting, has failed to meet its 2- to-4 percent inflation target in eight of the past 12 months.

Gasoline Tax

President Felipe Calderon, in a bid to quell inflation, yesterday postponed the imposition of a new 5.5 percent gasoline tax and halted fuel-price increases for the rest of the year.

Mexico's association of retailers also agreed to cap the price of a bread roll at 1 peso to keep soaring wheat prices from hurting the poor.

``This was a positive step,'' Perez said. Still, ``it's a partial solution that just postpones price increases.''

Yields on Mexico's 7.25 percent bond due December 2016, the government's 10-year fixed-rate benchmark in pesos, fell 2 basis points, or 0.02 percentage point, to 7.84 percent at 3:06 p.m. in New York. The price, which moves inversely to the yield, rose 0.14 centavo to 96.13 centavos, according to Banco Santander SA.

The first sale of the three-year inflation bond, known as Udibono, will be on Oct. 2, the Finance Ministry said. Mexico's government introduced the three-year inflation bond in 1996 and stopped selling it two years later.

Break-Even Rate

The re-introduction of the shortest-term inflation bond suggests the government may begin to sell a five-year inflation maturity next year as it seeks to add securities along the yield curve, said Salvador Orozco, head of fixed-income research at Santander in Mexico City.

The government today said the three-year inflation bond will pay a 3.25 percent coupon. The fixed-rate bond of the same maturity yields 7.63 percent. Should the government sell the inflation bonds at par, the gap between the yields on the two securities will be 4.38 percentage points.

This gap, called the break-even rate, represents the average rate of inflation needed over the life of the inflation securities for them to return as much as regular bonds.

In its financing plan today, the government said the amount of fixed-rate debt and peso Treasury bills it sells will remain unchanged in the fourth quarter.

Petroleos Mexicanos, the state-owned oil monopoly, may issue up to 17.5 billion pesos of bonds in the local market, the government said.

Mexico's peso was little changed today at 10.9223 per dollar.