Don’t Blame Trump for Bank of Mexico Raising Interest Rates

  • Hike this week may only offset rising inflation expectations
  • Pressure on rates may continue until clarity on gas prices

Mexico’s biggest problem right now isn’t Donald Trump.

The country is losing a battle against inflation. Officials have repeatedly given assurances that the rapid increase in prices would only be temporary, yet expectations continue to climb faster than the Bank of Mexico can raise interest rates.

Raising rates has been mostly a response to faster inflation after the government increased gasoline prices in January. The peso hasn’t helped either. Even though it only lost about 1 percent against the U.S. dollar since the last central bank meeting, the currency has depreciated about 13 percent since Trump’s election victory.

As a result, the central bank is set to raise interest rates by 50 basis points to 6.25 percent after increasing it by 150 basis points in the last six months, according to the median estimate in Bloomberg’s survey of economists. Even if Banxico meets the forecast, it would only offset increasing inflation expectations and keep the real policy rate stable.

Investors aren’t convinced either. Mexico’s TIIE swap curve prices a 125 basis point increase in the rate this year, ending at or just above 7 percent in 2017.

Mexico’s consumer prices rose the most in 18 years in the first two weeks of the year compared to the second half of December after the government gas price hikes kicked in. The move was an effort to cut subsidies in order to trim the budget deficit so the country could avoid having its sovereign rating cut.

The government said last week it will adopt new subsidies for gas prices and no more increases will happen until Feb. 17. The news is unlikely to sway the central bank’s decision on Thursday given the inflation outlook.

Inflation is expected to accelerate to 4.7 percent on an annual basis in January and finish the year at 5.25 percent, up from 3.41 percent a year ago, according to a Banxico survey released on Feb. 1. That compares to a central bank bank target of 2 percent to 4 percent. The one-year breakeven inflation rate has also held above the bank’s range over the past two months.

If gas prices and the peso stabilize, it would give the economy some breathing room from tighter monetary policy. Market pricing for hikes would also then get closer to the Federal Reserve’s funds futures.

With consumer confidence falling to the lowest on record in January, something needs to happen.

NOTE: George Lei is an FX strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice.

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