The battle being waged by Agustin Carstens to revive Mexico’s sluggish economy is at risk of being derailed by an unlikely adversary: the peso.
Carstens is set to deliver Banco de Mexico’s quarterly report on Wednesday, highlighting how inflation at a four-decade low and weak growth argue for leaving borrowing costs at their record-low 3 percent.
Yet in a nation where millions remember the chaos that wiped out personal savings during a peso crisis in 1994, the currency’s 19 percent plunge in the past year, in addition to the looming Federal Reserve liftoff, will require higher rates in order to maintain financial stability, analysts said.
Policy makers have started to spend international reserves to bolster the currency, and Carstens conceded to the Wall Street Journal that the central bank may have to raise rates before the next scheduled decision in September if volatility increases.
“If it weren’t for the Fed and the peso, the central bank probably would not be in a rush to hike rates,” said Rafael de la Fuente, chief economist for Latin America at UBS AG. “Clearly the peso is an issue, and financial stability is very important to them.”
Investors are now looking to Carstens to provide details on how the central bank will manage to stabilize the currency without choking growth. Policy makers have said the inflation impact from peso weakness so far has been limited to prices for durable goods, partly because the economy remains too weak to pressure broader prices.
But policy makers who expect growth to pick up have said they’re watching for signs that the peso is spurring faster price increases and will act to ensure inflation remains at its 3 percent target.
Some traders are betting that $200 million in daily dollar sales by the central bank won’t be enough to prevent the peso from falling. Societe Generale SA predicts a further retreat to 17.75 as the most liquid emerging-markets currency sells off.
The peso slid 1.3 percent to 16.3671 per dollar at 9:58 a.m. in Mexico City, the biggest intraday decline since June 5, joining a retreat in emerging-market currencies after China devalued the yuan.
Disappointment with President Enrique Pena Nieto’s administration after the nation’s first oil auction missed government expectations and lower crude prices that prompted public spending cuts are adding to the pressure in currency markets. Drug lord Joaquin “El Chapo” Guzman’s prison escape also hurt credibility and dragged down consumer confidence.
Economists have cut their 2015 growth forecasts for Mexico by more than a percentage point since October to 2.55 percent, a central bank survey showed Aug. 3.
The peso weakened to a record-low 16.4890 per dollar on July 30, and hours later the central bank and finance ministry quadrupled the size of a dollar sales program they started in March. While the currency has since strengthened, RBC Capital Markets forecasts a weakening to 17 per dollar, 4.9 percent below Monday’s closing level, saying the size of the daily intervention isn’t enough to deter sellers.
Daily dollar sales by the central bank are probably equivalent to about 1.7 percent of the estimated $12 billion pesos that trade daily, said Daniel Tenengauzer, head of global foreign-exchange strategy at RBC.
“The intervention is not that big in relation to the daily average trading in the peso market,” Tenengauzer said. “You’re going to have a level where the exchange rate has an impact on inflation.”
Tenengauzer said inflation pass-through may surprise policy makers and forecasts consumer prices will increase 3.2 percent this year, compared with the central bank’s forecast for inflation to stay below 3 percent. Inflation slowed to 2.74 percent in July, the least since 1968.
Traders in the forwards market are pricing in an exchange rate of 16.54 per dollar at the end of this year and 17.05 at the end of 2016, according to data compiled by Bloomberg.
“The intervention is like throwing sand on the wheels to slow down the move,” said Alonso Cervera, the chief Latin America economist for Credit Suisse Group AG. “If conditions were to worsen significantly, the central bank would have to follow through with the rate hike.”