Mexico raises rates in response to Trump victory

Posted on November 17, 2016

In the first policy response by a government to Donald Trump’s election triumph, Mexico’s central bank on Thursday lifted its main lending rate by 50 basis points to 5.25 per cent to help keep a lid on inflation, and said it stood ready to take further action if needed. 

The peso — a barometer of traders’ sentiment about what a Trump presidency could bring — initially shed more than 17 per cent in hectic post-election trading but has steadied in recent sessions.

Some in the market had been bracing immediately after the US election for a shock-and-awe rise of 100bp or more, but the currency’s recovery trimmed the consensus expectation to a 50bp rise. Still, some analysts complained the move was too timid.

“Some reaction from Mexico is better than no reaction. But today’s hike isn’t going to be enough. The peso has taken the brunt of the post-Trump sell-off in emerging market currencies. The central bank really needed to get in front of the situation by raising rates by at least 75bp,” said Edwin Gutiérrez, Aberdeen Asset Management’s head of emerging markets sovereign debt. “Today was a missed opportunity. We might see more aggressive selling-off of the currency now.”

The latest increase brings to 200bp the rise in rates this year after half-point moves in February, June and September as the peso suffered a severe lashing. The currency was trading about 20.4 to the dollar after the rate decision, having crashed through the 20-peso level for the first time in response to Mr Trump’s victory. 

The central bank stressed that prudent husbandry of state finances, including pre-financing all of next year’s foreign obligations and a solid financial system, put Mexico “in a position of strength to face up to this new environment”. 

The decision to raise its key rate “seeks to counteract inflationary pressures and keep inflation expectations anchored”, it said in a statement.

It added that it remained ready to “continue taking necessary measures to consolidate the efficient convergence of inflation to the 3 per cent objective, with full flexibility, whenever and to whatever extent conditions should require”. 

The bank’s next monetary policy meeting is on December 15, just after the US Federal Reserve’s meeting on December 13-14. Fed chair Janet Yellen said earlier on Thursday that a rise in short-term US interest rates could “become appropriate relatively soon” — raising expectations of increases on both sides of the border next month. 

“It’s clear that further [Mexican] hikes are on the cards. We expect another half-point increase at December’s meeting, taking the policy rate to 5.75 per cent by year-end, and further hikes next year too,” Edward Glossop, a Capital Economics analyst, said.

Mario Robles at Nomura said: “We believe waiting has value here before authorities potentially deliver more significant mitigating measures.”

Mexico’s central bank is keenly aware that higher borrowing costs will weigh on an economy for which analysts have chopped forecasts for next year. Some forecasts are now for 1.7 per cent growth or lower, compared with average market expectations of 2.3 per cent expansion in 2017.

The central bank’s 2017 forecast is 2.2 to 3.3 per cent, but some analysts even predict recession if Mr Trump were to implement everything he promised during his campaign, such as dismantling the North American Free Trade Agreement. 

Banxico’s overarching duty is inflation control, however, and Manuel Sánchez, a deputy governor of the central bank, told Bloomberg last week: “Until now the pass-through from the exchange rate to prices has been very modest … We’ve said that the risk worries us, but that doesn’t mean that there’s a linear, automatic, one-to-one relationship” between the peso and inflation. 

Inflation in October was slightly above the central bank’s 3 per cent goal. “We expect general inflation to continue increasing gradually to slightly above 3 per cent by the end of this year”, with underlying inflation “moderately above that level”.

Next year, inflation is likely to overshoot the 3 per cent target, only returning close to 3 per cent by the end of 2018, the bank said, although it added “this prediction is subject to risks”.

Mexico’s biggest challenge in readying its policy response to Mr Trump is that it is impossible to judge yet whether his election campaign bark was worse than his bite.

The government is in wait-and-see mode until the Trump team confirms appointments and policies, according to José Antonio Meade, the finance minister, at a roadshow with investors in New York on Wednesday.

Juan Pablo Castañón, head of the Mexican business lobby CCE, said the country needed a Plan B in the event that Nafta is undermined or scrapped, including offering incentives to repatriate capital held abroad to invest in infrastructure. 

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