Mexico's inflation rate in May hit a seven-month low, according to figures released this week, a sign that interest rate cuts might follow.

The increase in Mexico's consumer price index slipped to 5.8 per cent on an annualized basis for May. That reading represented the first time since October 2008 that inflation fell below the six per cent level.

The improved statistic also might give the central bank room to cut interest rates, analysts noted.

Economists often argue that lower inflation allows bankers to reduce borrowing costs because lenders need a smaller return to compensate for price increases.

A slowing economy

Experts are now focusing on Mexico's slumping economy, a sign that inflation is unlikely to return very quickly.

"The Mexican economy is on the ropes," noted a May commentary by Wells Fargo, a big U.S. bank.

Mexico's gross domestic product shrank a hefty 8.2 per cent in the first three months of the year.

And Wells Fargo currently forecasts a contraction of 5.5 per cent for Mexican GDP in 2009.

Meanwhile, the country's interest rates remain relatively high.

Currently, the main borrowing level set by the Mexican central bank stands at 5.25 per cent, down substantially from 8.25 per cent at the beginning of the year.

Losing a hard-earned reputation

But the Mexican government of Felipe Calderon needs to be careful not to cut rates too quickly, analysts said.

After years of high inflation, Mexico sliced its annual rate of price increases by keeping interest rates higher than normal.

"[As a result] investors have grown increasingly confident in the country’s commitment to macroeconomic discipline, allowing Mexico to greatly improve its public debt management," said Erwan Quintin and Edward Skelton, economists with the Federal Reserve Bank of Dallas in an article in November 2008.

High inflation equals high rates

Mexico's current economic strategy — keeping interest rates higher in order to cap inflation — actually is the norm for a number of countries, despite the global recession.

South Africa, for instance, posted an inflation rate of 8.4 per cent in April, still higher than the central bank's target of three per cent to six per cent on an annualized basis.

Thus, the country's main interest rate is 7.5 per cent.

Egypt, another African nation historically beset by high rates of inflation, managed to post its lowest CPI in 14 months in April. But that rate, 11.7 per cent, partly explains why Egypt's trend-setting interest rate is still high at 9.5 per cent.

Brazil, one of South America's more dynamic economies, faces a similar situation with inflation at six per cent in April. Brazil's inflation level for the month was still higher than the 4.5 per cent target set by the central bank.

As a result, Brazil's main interest rate is a lofty 10.25 per cent.

By contrast, more developed economies — Canada, the United States, Europe and Japan — face almost non-existent inflation. As a result, central banks in those regions have vaporized official interest rates.

The European Central Bank currently has set its main borrowing rate at one per cent, and inflation for the region stood at 0.6 per cent for April.

Prices in Canada dropped in April by 0.6 per cent. The Bank of Canada's overnight rate stands at 0.25 per cent.

Even in tiny Switzerland, the national bank has set its three-month maximum rate at 0.75 per cent. The country's inflation rate fell in both April and May.