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Categorized | Banks, Currencies

Mexico raises rates to shore up peso

Posted on June 30, 2016

Mexican peso coins©Dreamstime

Mexico’s central bank announced a higher than expected 50 basis point hike in its benchmark interest rate to contain inflation and shore up a peso that has taken a beating since Britain voted to leave the EU a week ago

It was the second time this year that the Bank of Mexico, or Banxico, led by Agustín Carstens, had taken such a bold move. In February, with the peso under pressure, it delivered an extraordinary half-point rise.

    The Bank of England, by contrast, announced earlier in the day that it expected to cut rates or renew quantitative easing this summer and is expected to slash growth forecasts in the wake of the vote to leave the EU.

    In a statement, Mexico’s central bank said that a “large deterioration” in external conditions could have an adverse effect on inflation that was already ticking up. Capital Economics said in a statement: “This is central bank-speak for ‘we’ve been spooked by the recent drop in the currency’.”

    Though Mexico has only a small trade relationship with Britain and little to lose directly from the EU vote, the peso is the most liquid emerging market currency, with $135bn traded daily. That status makes it an ideal vehicle to hedge risks.

    It took a hammering in the global Brexit market sell-off, briefly hitting an all-time low of 19.5187 against the dollar, although it later recovered and did not tank to levels of 20 or 21 as some analysts had feared.

    The currency had been treading water at about 18.48 to the dollar before Thursday’s bold hike prompted a sharp bounce to around 18.19. The peso, which has shed about 7 per cent this year against the greenback, later weakened again slightly.

    But Capital Economics noted that such recoveries can fade quickly — after the February rate hike, the peso soon came under renewed pressure.

    “Although the available information still suggests a base scenario for the short and medium term for inflation congruent with the permanent goal of 3 per cent, external conditions have suffered a significant deterioration, a situation which could adversely affect the future behaviour of inflation,” Banxico said.

    “With this action, we are seeking to avoid the depreciation of the national currency that we have seen in the past months, and the adjustment of some relative prices, translating into a de-anchoring of inflation expectations in our country,” it added.

    There’s still a lot of uncertainty. We don’t know if the Fed will hike and the peso is going to still be very volatile

    – Marco Oviedo, chief economist at Barclays in Mexico City

    The bank will remain vigilant and stood by to take any action, “with all flexibility and whenever conditions dictate”.

    Enrique Covarrubias, head of strategy, fixed income and economics at Actinver in Mexico City, said Banxico was betting that inflation was heading above 4 per cent — a far cry from the “very manageable” 2.6 per cent current headline rate.

    A rise in gasoline prices from July, announced this week, adds to higher food, merchandise and other price rises that are stoking inflation.

    Marco Oviedo, chief economist at Barclays in Mexico City, said the bank had little alternative. “There’s still a lot of uncertainty. We don’t know if the Fed will hike and the peso is going to still be very volatile,” he added.

    Carney prepares for ‘economic post-traumatic stress’

    Mark Carney, governor of the Bank of England (BOE), speaks during a news conference in the City of London, U.K., on Thursday, June 30, 2016. Carney said the Bank of England will probably have to loosen policy within months to deal with the fallout of the Brexit vote as he warned that there's only so much he can do to protect the economy. Photographer: Chris Ratcliffe/Bloomberg

    Bank hints at more easing as sterling falls and Gilts go negative

    A further rise of at least a quarter-point before the year-end is widely expected in the market.

    Before Banxico’s February hike, which came after the peso breached 19 to the dollar, the central bank had followed the US Federal Reserve with a quarter-point hike last December, and had been keen to keep in step with its northern neighbour. Brexit could represent a break with those plans.

    Also weighing on Mexico’s outlook is the US election, in which a vote for presumptive Republican nominee Donald Trump — who has pledged to build a wall between the neighbouring countries — is seen as negative for Mexico. Investors are also concerned about the financial health of state oil company, Pemex, and the risk of its liquidity crisis spilling over into government accounts.