Mexico: Banxico raises rates after peso plunge
September 29, 2016
The Central Bank of Mexico (Banxico) announced at its 29 September meeting its decision to raise the monetary policy rate by 50 basis points to 4.75%, returning to levels last seen in 2009. The increase was widely expected, but analysts had never been so divided with forecasts ranging from 25 basis to 75 basis points. Banxico began to tighten the reins in December 2015 and has raised the key interest rate by a total of 175 basis points since then.
The Bank’s decision to increase the interest rate followed a period of significant volatility in the peso, which in some retail outlets exceeded the 20.0 MXN per USD threshold. Banxico remained under pressure to support the weakening currency and in its statement it took a hawkish attitude towards keeping the currency from depreciating further as the authorities reiterated concerns regarding the combination of a depreciating currency and increased risks to inflation.
Regarding the Bank’s decision, Alexis Milo, Chief Mexico Economist, and Alejandro Martínez-Cruz, Senior Latam Fixed Income Strategist commented:
“We anticipated this outcome [the rate hike] on the back of the recent deterioration of the Mexican Peso, which stood out as one of the worst EMs FX performers in different time frames. The MXN had been weakening despite the latest FOMC's decision to keep the policy rate unchanged in September and a moderate recovery in oil prices, thus suggesting these developments had been largely priced in by the currency. In fact, the MXN has recently appeared particularly sensitive to the US election process due to the potential implications for the economy that may result. Hence, we perceive that Banxico's decision to hike the policy rate today was driven by the recent weak performance of the MXN on the grounds that it could impact inflation expectations.”
Although the interest rate increases this year have had immediate impacts in boosting the MXN, the effects have dissipated in a relatively short period of time. Consequently, it remains to be seen whether this rate increase will be sufficient to keep the peso from falling in the coming months, since the main drivers behind the peso weakening are external.
Looking forward, Banxico signaled that risks remain that volatility in domestic and international financial markets will intensify, especially if uncertainty rises regarding the outcome of the U.S. presidential elections, the implications of which for Mexico could be particularly important. Mexico Central Bank’s penultimate monetary policy meeting is scheduled for 17 November.
Author: Ricardo Aceves, Senior Economist