Mexico Monetary Policy June 2016


Banxico shows its muscle with rate hike in June

On 30 June, Mexico’s Central Bank (Banxico) hiked the overnight interest rate for a second time this year in a bid to support the peso, which has been hit hard by the market turmoil set off by the UK’s shocking vote to leave the EU. The hefty move by Banxico to raise rates by 50 basis points, from 3.75% to 4.25% comes just days after the peso closed at its weakest level ever against the U.S. dollar. Furthermore, the move was larger than markets had expected—only 5 of the 26 economists surveyed by Bloomberg predicting a 50-basis-point rise.

Gabriel Lozano, Mexico Chief Economist at J.P. Morgan, is one the analysts Bloomberg surveyed and is a panelist in our LatinFocus Consensus Forecast. Lozano had anticipated Banxico’s decision and said that the Bank would have to deliver such a hike in reaction to, “the lingering depreciation of the currency in order to maintain inflation expectations anchored. At present, Banxico’s order of priorities is: the performance of the exchange rate and its potential impact on inflation and expectations, followed by the relative monetary conditions versus the US and, finally, economic slack. While the economy continues to expand modestly and inflation remains below its long-term target of 3%, in our view the emphasis placed on exchange rate dynamics should suffice for Banxico to deliver a one-off hike later today.” Prior to the decision, J.P. Morgan had been projecting a 50-basis-point hike, but also stated, “we acknowledge that expectations of looser monetary policy globally and the likely delay in rate hikes in the US (we now see the next Fed hike in December) have increased the odds for Banxico remaining on hold, or for a milder 25bp hike to take place.”

In its statement, Banxico said that a large deterioration in external conditions, mainly due to the Brexit vote, could have an adverse effect on inflation. Moreover, the Central Bank emphasized that monetary authorities are seeking to avoid a substantial depreciation of the national currency and thus the adjustment of some relative prices, which for the Bank means, “a de-anchoring of inflation expectations.” The Central Bank added that it will remain closely vigilant against exchange rate disturbances and possible pass-through to consumer prices, as well as the relative monetary position between the U.S. and Mexico and Mexico’s current account deficit, and said it stood by to take any action, “with all flexibility and whenever conditions dictate.”

Following the decision Lozano said:

“Putting the pieces together, we think that the message was straightforward: Banxico will not tolerate the emergence of any macro imbalance in the context of renewed global financial volatility, even if this translates into slower economic activity, as these would eventually translate into inflation pressures that could endanger the convergence of inflation and inflation expectations to the 3% target. With no discretionary intervention in sight, authorities have relied on monetary policy to maneuver exchange rate dynamics, and we expect this policy to remain in place, with Banxico keeping its options open in the next months. We are forecasting the next hike for December 15, in line with J.P. Morgan’s expectation for a hike in the US the previous day. Our call is for a 25bp increase that would bring the policy rate to 4.5%.”

The Mexican peso is the most widely traded emerging market currency with USD 135 billion traded daily and is widely used as a hedge for less liquid currencies. That made it an easy target for punishment in the global sell-off in the aftermath of Brexit referendum. After the vote result, the MXN sank briefly to a new all-time low of 19.5 MXN per USD and saw its largest one-day drop in nearly five years, prompting market players to expect Banxico to intervene in the market or hike rates. However, many expected that the Brexit would send the peso into freefall to hit to 20.0 or 21.0 to the U.S. dollar, but this did not happen and the currency has stabilized and no intervention by Mexican authorities was needed. In fact, the peso was trading around 18.5 MXN per USD just before the Bank of Mexico announced its rate decision.

In the wake of the Bank’s decision, Benito Berber, Senior Latam Strategist at Nomura, pointed out that there are additional risks to the peso lingering on the horizon:

“Super-Banxico lent a helping hand to the battered MXN, which was one of the worst performers among EM currencies in the year. It had not been trading well due to mounting risks, including the potential scenario that presumptive presidential nominee Donald Trump wins the US election. The risk of Brexit added noise to the MXN, and while the expectation of a dovish Fed partially abated such noise in the past few days, the MXN was among the currencies that rallied the least. Concerns about the fiscal outlook, particularly stemming from a difficult situation at Pemex, also affected the MXN.”

On average, the view of the panel of analysts surveyed by FocusEconomics is that the target of the overnight interest rate will end 2016 at 4.50%. For 2017, forecasters see the target of the overnight interest rate ending the year at 4.82%.

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Mexico Monetary Policy Chart

Mexico Monetary Policy July 2016 2

Note: Banxico target rate (Tasa objetivo de fondeo bancario) in %.
Source: Mexico Central Bank (Banxico).

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