Mexico Raises Interest Rate After Peso Plunges to Record Low

  • Peso fell to record this week on Trump, public debt concerns
  • Third hike of year after half point each in February, June

Mexico raised borrowing costs for the third time this year on concern that the peso’s tumble to a record low may fuel faster inflation and threaten to roil the nation’s financial markets.

Banco de Mexico increased the overnight rate a half point to 4.75 percent on Thursday, the highest level since 2009. Economists surveyed by Bloomberg before the decision had never been so divided, with forecasts for an increase ranging from a quarter-point to three quarters of a point.

The central bank, led by Agustin Carstens, reiterated concern about the combination of a depreciating currency and increased risks for higher inflation, even as the bank noted that Mexico’s growth outlook has deteriorated. The peso has weakened this year on concerns including Donald Trump’s improved standing in the U.S. presidential election, a widening current account gap and deteriorating public finances.

"For the very short term, the election is going to be the primary focus for the currency and markets in Mexico," said Rafael Camarena, an economist at Grupo Financiero Santander Mexico SAB in Mexico City, who forecast the half-point increase. "The central bank is acting in a preventive manner to strengthen Mexico’s macroeconomic fundamentals."

Currency Volatility

The Mexican peso reversed gains that followed the decision to trade down 0.5 percent against the U.S. dollar at 19.4734 per dollar from 19.3801 yesterday. The peso fell 3.1 percent this month through Wednesday and reached a record low this week in the hours before the first debate between Trump and Hillary Clinton. The currency has repeatedly weakened this year when Clinton’s lead over Trump narrowed in polls, as it has in September.

"Going forward, there remains a risk that volatility in domestic and international financial markets will intensify," the central bank’s board wrote in the statement accompanying its decision. "This is especially true if nervousness grows about the consequences of the U.S. elections, whose implications for Mexico could be particularly important."  

Analysts forecasting a hike highlighted the risks to the economy stemming from the peso’s depreciation. Economists who expected the bank to keep rates unchanged cited below-target inflation and signs of slowing growth.

The central bank has repeatedly taken measures this year to head off capital outflows and stem losses in the currency, among the most-traded in the world and traders’ favorite proxy to hedge against emerging-market risk.

Banxico’s Aims

The board surprised analysts with a half-point increase at an unscheduled meeting in February and then again by the same amount in June. In both cases, the peso’s rebound proved short-lived.

Trump has proposed ending or renegotiating Nafta, which has been key to Mexico moving from a largely closed economy to a global export and manufacturing powerhouse over the past two decades. He’s also said he may seize remittances to make Mexico pay for a $10 billion border wall.

While saying that the decision isn’t part of a rate hiking cycle, the central bank explained that it is seeking to keep inflation expectations "anchored" as global market volatility "worsens."

The central bank has reduced its 2016 growth forecast four times, most recently to an estimate of 1.7 percent to 2.5 percent. At the same time, inflation has been below the bank’s 3 percent target for the last 16 months.

"The peso’s drop has been very important," Carlos Capistran, the chief Mexico economist at Bank of America Corp. in Mexico City, who expected a half-point increase, said before the decision. "The depreciation risks unanchoring inflation expectations. In hiking, they strengthen Mexico’s macroeconomic fundamentals."

— With assistance by Rafael Gayol

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