Peso Undervalued By Any Measure With Room to Rise: Carstens

  • Carstens says Trump win is one event that could spur rate hike
  • Mexico raised interest rate to 4.75% after peso hit record low

Mexico’s peso is undervalued by "all measures," and has quite some room to appreciate under normal circumstances, central bank Governor Agustin Carstens said.

The central bank is comfortable with the current monetary policy stance after yesterday’s 50 basis-point increase in the country’s benchmark interest rate. Still, if hit by an extraordinary event, such as a potential victory of Republican candidate Donald Trump to the U.S. presidency, that could spur a rate hike, Carstens said in an interview in his office in Mexico City.

"Unless something really extraordinary happens, given the information we have today, we feel comfortable with this monetary policy stance," he said. Asked if a Trump victory could be such an extraordinary event, he said "that could be one. It depends on how it happens, what he says, how he acts. It’s not as simple as putting a label. There’s still uncertainty and we have to see in a given case how he performs."

The peso’s real effective exchange rate -- its trade-weighted value versus a basket of other major currencies, adjusted for inflation -- shows it’s undervalued compared with historical norms. The measure fell to the lowest since 2009 on Monday, according to a Barclays index, and is 15 percent below its 10-year average.

The central bank has gone to great lengths to bolster a weakening peso and head off capital outflows by raising borrowing costs a total of 1.5 percentage points this year to 4.75 percent, saying a weak exchange rate could fan inflation. Yesterday policy makers reiterated their concern about the combination of a depreciating currency and increased risks for higher inflation, even as economic growth slows, warning that nervousness about U.S. elections could intensify volatility in financial markets.

The third increase this year came even as inflation has remained below the 3 percent target for more than a year now. Banxico said yesterday that although inflation and expectations for future price increases were anchored, risks to inflation had worsened.

Carstens explained today his concerns about inflation and the weak peso’s pass-through to consumer prices: "The parameter of the pass-through has been low and we expect it to continue to remain low, but the depreciation has been sizeable, so i think there’s still some room for more inflation to be seen, particularly in core inflation."

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The central banker said that if the currency commission intervened to sell dollars, it would probably take them from the nation’s international reserves rather than tap a flexible credit line from the International Monetary Fund. "At this stage we feel comfortable with the level of reserves we have," Carstens said. "With respect to our communication with the fund, we’re trying to use this instrument more as a precautionary instrument."

Peso’s See-Saw

The peso has weakened this year by the most among major currencies after the British Pound on concerns including Trump’s improved standing in the U.S. presidential election, a widening current account gap and deteriorating public finances. The currency reached a record low in the hours before the first U.S. presidential debate on Monday before rebounding amid investor perceptions that Hillary Clinton outperformed Trump. The Republican candidate has proposed renegotiating or ending trade deals with Mexico and blocking remittances to force Mexico to pay for a wall along the U.S. border.

The peso gained 0.7 percent on Friday to 19.3852 per U.S. dollar from 19.5213 yesterday. The currency’s 2.1 percent gain against the dollar in the past five days was the best performance among 31 major counterparts tracked by Bloomberg and trimmed its 2016 decline to 11.2 percent.

The bank also said that the decision wasn’t part of a rate hiking cycle. After strengthening considerably following the first rate increase this year in February at an unscheduled meeting, the peso has shown little reaction in the market from the two subsequent decisions. The currency weakened yesterday 0.7 percent, although it outperformed other major exchange rates today.

Carstens said that beyond Trump’s threats about building a border wall or renegotiating the North American Free Trade Agreement, his biggest concerns about the candidate were about longer term effects. "What would concern me the most is if the very close relationship and cooperation between Mexico and the U.S. is in some way affected," Carstens said. "Very broad and close cooperation is of the essence."

— With assistance by Isabella Cota, Sebastian Boyd, and Jonathan Roeder

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