Mexico stunned markets Thursday by increasing interest rates by half a percentage point, in a move by the central bank to outpace the US Federal Reserve that no top economist predicted. The peso jumped on the surprise decision.
(Bloomberg) — Mexico stunned markets Thursday by increasing interest rates by half a percentage point, in a move by the central bank to outpace the US Federal Reserve that no top economist predicted. The peso jumped on the surprise decision.
Banxico, as the central bank led by Governor Victoria Rodriguez is known, raised its key rate 50 basis points to a record 11%, matching its half-point hike in December. The board also said in a statement that it could deliver a smaller hike at its next meeting.
The move surprised all 24 economists surveyed by Bloomberg who had expected the bank to slow the pace of tightening to a quarter point. The decision comes after the central bank signaled at its December meeting that it would boost rates again in its first decision of the year.
The board “deemed that, given the dynamics of core inflation, on this occasion it is necessary to continue with the magnitude of the reference rate adjustment,” it said in a statement accompanying the decision. “Given the monetary policy stance already attained and depending on the evolution of incoming data, for its next policy meeting, the upward adjustment to the reference rate could be of lower magnitude.”
Inflation in Latin America’s second-largest economy has made only minimal progress back to target since peaking in September. After initially slowing from its 8.7% high, price growth ticked up slightly in December and again in January to 7.91%.
The Mexican peso rallied as much as 1.1% versus the dollar to a session high of 18.7366 after the surprise rate hike. That point is also the strongest since Feb. 3, when the currency reached a 2023 high at 18.5080 per dollar. Mexico’s swap rates surged after the central bank decision, with two-year TIIE rising almost 50 basis points at one point.
The bank’s hawkish surprise came at the first meeting since the departure of Gerardo Esquivel, who was consistently the board’s most dovish member and regularly voted to slow the pace of tightening. He was replaced by Omar Mejia, who joined the five-member board in January after previously working as an adviser to fellow Deputy Governor Galia Borja.
It was also the first unexpected move since former budget official Rodriguez took the helm at the bank at the start of 2022.
What Bloomberg Economics Says
“Thursday’s surprise should bolster the central bank’s credibility, support the peso and help anchor inflation expectations. Forward guidance anticipated a 25-bp hike in March and kept the door open for a bigger move and additional tightening if new data warrant.”
— Felipe Hernandez, Latin America economist
— Click here for the full report
The bank at the same time sharply revised its inflation projections upwards, showing a deterioration in expectations for the next two years. It now expects price increases at 6.4% in the second quarter, up from 5.9% in its December forecast. The bank sees inflation ending the year at 4.9%, from 4.2% in December.
“This will help re-anchor inflation expectations,” said Carlos Capistran, chief economist for Mexico and Canada at Bank of America Corp. “This is hawkish not only because it was a surprise to the upside but also because it was a unanimous decision to surprise the market and because it does not close the door to further hikes.”
The Fed delivered a quarter-point increase last week, leading analysts to forecast that Mexico would match its northern neighbor for the seventh straight decision.
“We are still figuring out what happened,” said Jessica Roldan, chief economist at Casa de Bolsa Finamex, which boosted its terminal rate projection to 11.5%, from 11% after Thursday’s announcement. “Today’s news support our view that inflation dynamics are deteriorated, that rates will be at high levels for longer and that a catch-up to the upside in inflation expectations is pending.”
Terminal Rate
Economists’ top question going forward is whether, and how far, Banxico would continue to outpace the US central bank, after Fed Chair Jerome Powell said he expected a “couple” more hikes in this cycle.
“All in all, Banxico did decouple from the Fed, but on the upside instead of ending its hiking cycle,” Gabriel Casillas, Barclays Plc’s chief Latin America economist, said.
Banxico has boosted its key rate a record 700 basis points over 14 straight meetings starting in June 2021 to the highest since the central bank began targeting inflation in 2008. It started its cycle about nine months before the US central bank leading some to question whether Mexico should “decouple” from its northern neighbor.
Deputy Governor Jonathan Heath told Bloomberg News last month that he “intuitively” saw the cycle ending between 10.75% and 11.5%. “I don’t see it above 11.5%, actually not even much higher than 11%, but that will depend on the data,” he said, noting that his comments reflect his views alone.
Read More: Banxico Should Keep Its Peak Rate for Six Months, Heath Says
After slowing sharply in October and November, inflation has stalled over the last two months. Especially concerning for the bank, core inflation, which strips out volatile items and is closely watched in Mexico, remains at 8.45% and has yet to show a clear downward trend. The bank targets inflation at 3%, plus or minus 1 percentage point.
Economists expect inflation to finish 2023 at 5.15%, according to a Citibanamex survey published this week, up from a forecast of 5.02% a month ago. Mexico’s economy is seen growing 1.2% this year, down from 3% in 2022, according to economists surveyed by Bloomberg.
–With assistance from Rafael Gayol, Alex Vasquez, Carolina Gonzalez, Dale Quinn, George Lei, Sydney Maki and Maria Elena Vizcaino.
(Adds Bloomberg Economics section after second chart. A previous version corrected a reference to Banxico’s December forward guidance.)
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