Published On: Thu, Sep 29th, 2016

Mexico increases interest rates to stem inflation and bolster peso

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MEXICO CITY—The Bank of Mexico raised interest rates by a half percentage point Thursday Sept. 29, making good the expectations of most economists, in a bid to contain inflation and bolster a peso hovering near record-low levels.

The Wall Street Journal reported the central bank led by Agustín Carstens increased the overnight rate to 4.75%. But the bank sought to reassure investors that the half-percentage-point rate increase won’t necessarily be repeated at the next meeting, saying that “it isn’t the start of a tightening cycle.”

The Bank of Mexico said that the move “seeks to counter inflationary pressures and keep inflation expectations anchored.”

Bank of Mexico Gov. Agustín Carstens. PHOTO: SUSANA GONZALEZ/BLOOMBERG NEWS

Bank of Mexico Gov. Agustín Carstens. PHOTO: SUSANA GONZALEZ/BLOOMBERG NEWS

It is the third time this year that the bank has increased borrowing costs, having made moves of the same size in June and February.

Annual inflation has been below the bank’s 3% target for the past 15 months, but picked up in the first half of September to its highest level in seven months. The bank has a sole mandate to keep inflation under control.

The peso has been a concern for the central bank, as the 13% depreciation of the past year could end up triggering price increases and pushing inflation above target. A weak peso makes imports more expensive.

The peso gained ground after the rate increase and was quoted in Mexico City at around 19.4230 to the U.S. dollar, compared with 19.50 before the decision.

In its policy statement, the Bank of Mexico said it is “closely watching the exchange rate and possible pass-through to prices,” but added that it isn’t targeting a specific exchange rate. The bank didn’t rule out further depreciation of the currency due to an “uncertain external environment.”

The peso is the 10th-most-traded currency and frequently used as a proxy to hedge global risks. In the past year, it has suffered selloffs caused by different factors, from Britain’s vote in June to leave the European Union to increasing expectations the U.S. Federal Reserve will interest raise rates this year.

More recently, the U.S. presidential race has driven peso volatility. On Monday, the peso made its second-largest gain of the year as investors bet that Democratic candidate Hillary Clinton was seen as the winner of the presidential debate against Republican Donald Trump, whose protectionist proposals could damage Mexico’s economy.

“It appears that a majority of policymakers were still spooked by the 4% drop in the peso against the dollar over the past month—which appears to have been due at least in part to Donald Trump’s greater chances of winning the U.S. election in November,” said Edward Glossop, economist at research firm Capital Economics.

With its Thursday decision, the central bank disappointed a minority of economists who argued the bank should stand pat on rates to keep some leverage to act in the event Mr. Trump wins the November election, or other potential negative shocks.

Several economists said a rate increase could hurt further an economy that is already slowing down. The economy shrank 0.2% in the April-June period compared with the previous quarter.

The central bank said it would remain vigilant and prepared to take any action, “with all flexibility, and whenever conditions dictate.” Most economists expect the bank to raise rates again if the Fed does in December.

The central bank’s five-member board said inflation is expected to gradually increase and end the year slightly above the 3% target. The economy, meanwhile, remains weak and growth prospects have deteriorated, the bank said.






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