Mexico Leaves Rate Steady as Peso Recovers From Brexit Swoon

  • Policy makers had raised rate half a point in June to 4.25%
  • Currency is worst performer this year after British Pound

Mexico’s central bank kept its key interest rate unchanged, saying that a half point increase in borrowing costs in June is helping to curb inflation risks.

Banco de Mexico led by Governor Agustin Carstens held its overnight rate at 4.25 percent Thursday, a move predicted by all but one of 28 economists surveyed by Bloomberg. One analyst had forecast a 50 basis-point increase. Thursday’s decision follows the rate hike on June 30 that came amid market turmoil over the U.K.’s vote to leave the European Union.

Since then, Mexico’s currency has recovered from its plunge to record lows triggered by the Brexit vote, while consumer price increases have remained below the central bank’s 3 percent target for the past 15 months. Mexico took bold steps to prevent the peso’s weakness from quickening inflation, including surprising markets with a half-point rate hike in February at an unscheduled meeting. Now Banxico says that inflation risks are neutral, while the economic growth outlook has deteriorated.

"They probably stayed on hold this time in light of the very benign inflation numbers, the weak growth indicators and the recovery in market sentiment toward the peso and emerging markets in general," said Alonso Cervera, chief Latin America economist at Credit Suisse. "Future moves will be largely dependent on the behavior of the peso, as well as on whatever the Fed does."

Domestic Demand

Gross domestic product contracted in the second quarter from the previous three months for the first time in three years, according to preliminary figures published July 29. Domestic demand growth weakened after bolstering the economy in previous quarters. Final growth figures will be published Aug. 22, but already economists see GDP rising only 2.3 percent this year, down from 2.5 percent in 2015, according to a Bloomberg survey.

The peso maintained its gain, climbing 1.3 percent to 18.1879 per dollar and touching the strongest level since the Brexit vote. While the currency has strengthened since its post-Brexit swoon, it remains the worst performer among major currencies this year after the British Pound, falling 6.6 percent through Wednesday. One-year interest-rate swaps fell for a sixth straight day reflecting lessened expectations for a rate increase.

"The economy has decelerated and therefore we don’t foresee demand-side pressures, which will keep inflation under control," Marco Oviedo, chief Mexico economist at Barclays Plc, said in an e-mailed response to questions before the rate decision. "Banxico has space to only move the rate if the Fed does."

Core Inflation

Policy makers, who have said on several occasions that they would prefer to match U.S. policy moves, have veered from the Federal Reserve’s path twice this year after the peso weakened, increasing the key rate a total of 1 percentage point.

Central bank Deputy Governor Manuel Sanchez said Aug. 5 that while a recent increase in core inflation is worrisome, the peso’s plunge has had a minor impact on driving up inflation. Sanchez, who analysts consider among the most hawkish members on Banxico’s board, alluded to the central bank’s credibility and interest rate decisions as limiting risks to inflation.

Earlier this week, Mexico reported that annual inflation quickened less than expected in July to 2.65 percent, while core inflation, which excludes energy and farm costs, has reached 2.97 percent. Rising core prices are among the reasons that Mexico will raise rates again as soon as September, and by 50 basis points, according to Grupo Financiero Banorte SAB in Mexico City.

The inflation outlook "has deteriorated, above all because of the upward trend we’re seeing in core prices," Delia Paredes, executive director of economic analysis at Banorte, said before the decision.

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