Mexico to hike rates if inflation persists

The central bank has not raised interest rates since 2008

Gulf News

Mexico City: Mexico’s central bank said on Friday it could tighten monetary policy soon for the first time in four years if inflation persists and price pressures do not abate.

The Banco de Mexico left rates at 4.5 per cent, where they have been since mid-2009, pointing to increased worries about growth and inflation, although it expected inflation had peaked at September’s 2-1/2 year high.

“Nonetheless, if inflation shocks persist, even if you assume that they are temporary, and a change in the trend of headline and core inflation is not confirmed, the board estimates that it could be appropriate to adjust rates upwards soon,” policymakers said in a statement.

The blunt warning raised the level of concern about inflation compared with the last meeting, when the central bank said it would keep a close eye on prices to see if a rate increase was warranted, but gave no timeframe.

The Banco de Mexico has not raised interest rates since 2008 and the surprisingly tough stance pushed the peso into positive territory as markets moved to price in the chance of rates rising sooner than expected.

Just after the decision, interest rate swaps suggested a 25 basis point rise as soon as July 2013 compared with in early 2014 before the statement, but they shifted back to December 2013 in the afternoon.

Hawkish stance

Economists said they did not think the central bank would act on its threat, even though the statement was the most hawkish since Agustin Carstens took the helm of the central bank in January 2010.

“I think they are trying to manage expectations without resorting to a rate increase,” 4Cast economist Pedro Tuesta said. “Carstens has played it well, but he’s not going to hike.”

Carstens himself said the strong words were justified by “deep concern” about the direction of inflation and a feeling that price pressures might not abate with action.

“There are risk factors that are present and have increased and that might make it more difficult to bring down inflation without monetary policy instruments,” he told reporters in Minneapolis, according to Bloomberg.

Inflation in Latin America’s second-largest economy has already started to ease from the 4.77 per cent recorded in September and declined to 4.64 per cent in the first half of October.

Inflation target

The Banco de Mexico, which has an inflation target of 3 per cent, with a one percentage point tolerance band, said the recent rise in the peso, prompted by the US Federal Reserve’s third round of bond buying, should help cool Mexican inflation.

It expects inflation to keep easing in the coming months and be “very close to 4 per cent” towards the end of the year, drifting towards 3 per cent in 2013.

Nomura economist Benito Berber said the central bank was betting that slow growth and weakness in the United States, Mexico’s main trading partner, meant policymakers would not have to act on the rate increase threat.

He said Carstens is shorting inflation in a way — “‘if inflation goes up, I hike.’ I bet you that all his models indicate that inflation will not go up. Because I have very simple models that say the same.”

Slower growth is also expected to keep a lid on price pressures. Mexico’s economy grew an average 4.3 per cent in annual terms in the first half of the year, but the finance ministry is forecasting a more moderate expansion of 3.5 per cent to 4 per cent for the whole of 2012.

Growth in risks

“The balance of risks for growth in the Mexican economy has continued to deteriorate, reflecting the intensifying downside risks to the global economy and in particular for the US economy,” the central bank said.

Data released earlier this week showed the economy’s annual rate cooling to 3.51 per cent in August, although the jobless rate fell to a pre-recession low the following month.

The central bank said one of its main inflation worries was a recent pick-up in salaries, where growth accelerated to close to 5 per cent annually in September, and said that a return of financial market turbulence could not be ruled out.

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