Bank of Mexico hikes rates to support peso; likely to hike next in December

The Bank of Mexico, on Thursday, raised the policy rate by 50 basis points to 4.25 percent in a bid to stop the depreciation of Mexican peso to spill over on inflation expectations. This was Banxico’s first rate hike since the unexpected intervention to fight the peso’s depreciation in February. The market had widely expected the central bank to hike rates by 25 basis points; however, there were mixed views before the central bank’s meeting.

Nordea Bank, in a research report, stated that it had anticipated the Bank of Mexico to keep rates unchanged as inflation continues to be quite low, downside risks to activity remain and as a result of last days appreciation of  the peso seen post Brexit sell-off.

The central bank’s monetary policy board stated that even if the available inflation implies that the “baseline scenario of inflation in the short and medium term is still consistent with the 3 percent target, external conditions have deteriorated significantly that could adversely impact future inflation”.

The Mexican peso is expected to remain stable in the future. Given this assumption, the Bank of Mexico is likely to hike its rate shortly after the US Fed in December. The central bank is likely to hike rate to 4.5 percent by the end of 2016, according to Nordea Bank. But if the Mexican peso weakens considerably, the central bank might hike rates more irrespective of the US Fed's stance.

A stronger US dollar, likelihood of Trump's victory in the US Presidential election and the risk sensitivity of the peso hint at persistent underperformance of the MXN in the near term.

Meanwhile, solid fundamentals continue to support the view of a stronger MXN in the long term, added Nordea Bank.