Mexico Keeps Rate Steady as Peso Strengthens and Fed Holds

  • Inflation remains below 3% but is expected to rise temporarily
  • Banxico's February increase was second in three months

Mexico kept its overnight interest rate unchanged after the peso’s rebound from a record low eased inflation pressures and the Federal Reserve left borrowing costs on hold.

Banco de Mexico, led by Governor Agustin Carstens, held the overnight rate at 3.75 percent Friday as forecast by all 25 economists surveyed by Bloomberg. The central bank said it will pay special attention to the exchange rate and its possible pass-through to consumer prices, while a faster peso appreciation could lower inflation, according to the statement accompanying the board’s decision.

The board lifted borrowing costs half a point in an unscheduled meeting as part of coordinated actions with the government announced Feb. 17 to bolster the currency and head off an increase in inflation expectations. The peso has responded well, strengthening the most among major currencies after Brazil’s real since then. That appreciation opens the door for the central bank to return to its previous strategy of pairing rate increases with the Fed, according to Goldman Sachs Group Inc.

"It’s a bit of a victory lap, that the measures announced Feb. 17 were very effective in anchoring the currency," said Alberto Ramos, chief Latin America economist at Goldman Sachs in New York. "If the currency remains well anchored, if there is no evidence of significant pass-through to domestic prices, they will match whatever the Fed does over the next meetings."

Risk Assessments

The Fed kept rates steady on Wednesday and scaled back forecasts for interest-rate increases this year due to weaker global growth. Mexico’s central bank cut its own forecast for the nation’s growth this year to 2 percent to 3 percent from 2.5 percent to 3.5 percent on March 3, saying that slower U.S. industrial activity will hurt demand for the nation’s goods. The U.S. is the destination for 80 percent of Mexico’s exports.

Banxico said in its statement that the nation’s economic expansion has decelerated with respect to the third quarter of last year, with some signs of private consumption slowing. "The board will follow very closely the evolution of all inflation determinants and expectations for the medium and long term, especially the exchange rate," according to the statement. "It will also be alert to the relative monetary position between Mexico and the U.S., without neglecting the evolution of the output gap."

Economic weakness in Mexico and the peso’s recent appreciation, along with a rise in global oil prices and a dovish Fed, make it more likely the central bank will remain on hold for longer, according to Bank of America Corp.

"Given the turn of events since Banxico hiked 50 basis points, now the risk is that if things continue to be this way, the economy may decelerate," Carlos Capistran, chief Mexico economist at Bank of America, said before the rate decision.

Capistran sees Banxico remaining on hold until a quarter-point increase in the fourth quarter, adding that he doesn’t see the central bank cutting rates as global uncertainty could lead to more peso weakness. The peso is the second-best performer among the 16 most traded currencies since reaching a record low of 19.4448 per dollar on Feb. 11, rising 12 percent. The peso dropped on Friday and maintained its loss after the decision, weakening 0.4 percent to 17.3815 per dollar at 2:05 p.m. in Mexico City.

Manuel Sanchez, a central bank deputy governor, said in an interview March 8 that he’s concerned about the risks of further peso depreciation spurring inflation. After slowing last year to levels not seen since the late 1960s, inflation quickened to 2.87 percent in February. Policy makers expect the annual pace of consumer price increase to rise slightly above the 3 percent target in the second and third quarters.

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