This is an archived article that was published on in 2014, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

Mexico City • After Mexico's economy failed to gain much traction during President Enrique Pena Nieto's first two years in office, growth is finally starting to pick up. That's prompted traders to predict the first interest-rate increase since 2008.

The odds that Banco de Mexico will lift its benchmark rate in the next year have jumped to 32 percent, from zero two weeks ago, after an Aug. 21 report showed the economy grew faster than analysts' estimates in the second quarter. The central bank has reduced rates 1.5 percentage points in the past 17 months to 3 percent, the lowest in Latin America.

With the economy topping forecasts for the first time in six months, traders are wagering that Gov. Agustin Carstens will look to reverse the rate cuts to guard against a rise in inflation. While Pena Nieto has pushed through sweeping changes to the nation's oil laws that are poised to fuel foreign investment in Mexico and propel growth, the economy last year posted its weakest expansion since 2009 and disappointed analysts earlier this year, hurt by tax increases and a slump in the United States.

"The strong recent data, in particular the second-quarter GDP report, creates more certainty that the next move in Mexico will be a rate hike and not a cut," Bill Adams, senior international economist at PNC Financial Services Group in Pittsburgh, said in a telephone interview.

Ricardo Medina Macias, a spokesman for Banco de Mexico, declined to comment on market expectations regarding monetary policy.

Mexico's gross domestic product expanded 1 percent in the second quarter from the previous three months, equal to an annualized rate of 4.2 percent, the national statistics institute said Aug. 21. The median estimate of 14 analysts surveyed by Bloomberg was for growth of 0.8 percent. The economy grew just 1.1 percent last year.

Increased exports to the U.S., Mexico's biggest trade partner, and a recovery in the services industry buoyed the economy, deputy Finance Minister Fernando Aportela said Aug. 21.

The government forecasts growth will continue to accelerate after Pena Nieto broke state-owned producer Petroleos Mexicanos's production monopoly, allowing companies such as Exxon Mobil and Chevron to explore for oil. The government plans to award the first contracts to private oil drillers in May as part of changes that Pena Nieto said in a televised roundtable with journalists last week could bring an extra $250 billion in foreign investment and help lift annual growth close to 5 percent by the end of his term in 2018.

Investment in the energy industry will add as much as 0.8 percentage point to economic growth next year, according to Marco Oviedo, chief Mexico economist at Barclays. He forecasts an expansion of 3.7 percent in 2015, which will cause inflation to accelerate and the central bank to raise rates.

"If everything goes as we expect, growth stabilizes in coming quarters and the economy starts growing close to the potential rate by September of next year, we're going to start seeing some demand-side pressures on inflation," Oviedo said by phone from Mexico City.

The annual inflation rate climbed to a five-month high of 4.07 percent in July. The central bank forecasts inflation will slow toward its 3 percent target early next year.

Delia Paredes, an economist at Grupo Financiero Banorte, Mexico's largest publicly traded bank, said the central bank may keep rates at a record low if the economy fails to show continued improvement.

Policymakers lowered their 2014 growth forecast for the third time on Aug. 13, saying GDP will rise 2 percent to 2.8 percent, down from their previous estimate of 2.3 percent to 3.3 percent.

"It isn't clear to us that they're going to raise rates," Paredes said by telephone from Mexico City.

The central bank will lift borrowing costs in the third quarter of next year, according to the median forecast of economists surveyed by Bloomberg.

Higher interest rates in the U.S. would also add pressure on Mexico to follow suit as it seeks to keep the peso from weakening, PNC's Adams said.

The Federal Reserve will probably increase borrowing costs by a quarter point to 0.5 percent at its meeting in July, according to the median forecast of analysts surveyed by Bloomberg. The difference between rates in Mexico and the U.S. is 2.75 percentage points, the least since Mexico adopted a target for the overnight bank funding rate in 2008.

"The central bank sees the interest-rate differential as important to supporting the value of the Mexican peso and preventing depreciation of the peso when U.S. interest rates rise," Adams said.