Mexico Hikes Interest Rate, Citing Peso Pressure From AMLO

(Bloomberg) -- Mexico’s central bank raised its key interest rate Thursday, saying President-elect Andres Manuel Lopez Obrador’s decision to cancel a $13 billion airport and broader policy uncertainty with the new administration have worsened the inflation outlook by weakening the peso.

Policy makers led by Alejandro Diaz de Leon lifted borrowing costs, already at the highest level in almost a decade, by a quarter point to 8 percent. The increase was anticipated by 20 economists surveyed by Bloomberg, while six projected it to remain unchanged. One board member voted for a half-point hike, making it the second split decision in as many months.

In an unprecedented commentary, the central bank specifically cited the incoming leftist leader’s decision to cancel the new Mexico City airport as a catalyst for the peso’s weakness. Should the peso face further real economic shocks, the central bank will contribute to an orderly adjustment, policy makers said. Their statement at least four times mentioned that Mexico is facing a period of uncertainty and warned that deterioration in public finances could further hurt the peso.

"The statement accompanying the decision was very hawkish," Edward Glossop, Latin America economist at Capital Economics, wrote in am e-mailed report. "The focus over the next six months or so will be on keeping policy tight to reinforce macro stability and offset political risks," he said, predicting another half-point of rate increases.

The peso maintained its gain following the decision, rising 0.9 percent to 20.2338 per dollar in afternoon trading. Interest-rate swap traders anticipate another increase, with current implied probabilities showing 94 percent chance of a quarter-point increase to 8.25 percent at the next meeting Dec. 20.

The peso has tumbled 5.1 percent since Lopez Obrador announced the airport cancellation Oct. 29, the most among major currencies, falling to weaker than 20 per dollar. The nation’s 10-year sovereign dollar bonds fell to a seven-year low and the benchmark stock index tumbled to the lowest since early 2016 after lawmakers from his Morena party unexpectedly proposed eliminating some bank fees, dealing a further blow to certainty and investor confidence.

As in recent decisions, the central bank listed the peso’s impact on inflation as its first priority, followed by Mexico’s monetary posture relative to the U.S. and the degree of slack in the economy. The balance of risks for inflation and growth have both deteriorated, policy makers said.

"It’s interesting to see all the explicit ’warning’ references directed to the incoming administration," Tania Escobedo Jacob, a strategist at RBC Capital Markets said in an interview from New York. "Banxico has always been very politically correct and only hinted its stance to topics outside its core mandate very carefully."

"I am happy they did it," she added. "This is not the time to send messages between the lines, right?"

AMLO, as Lopez Obrador is known, is due to present his budget to Congress by Dec. 15 after being sworn in at the start of next month.

On Wednesday, board member Roberto del Cueto unexpectedly announced that he’s resigning from the board, citing his health. That means Lopez Obrador will get to replace two of the five members within his first weeks in office. He previously signaled his intention to choose private sector economist Jonathan Heath to replace Manuel Ramos Francia. Some analysts are concerned Lopez Obrador could have too much influence over the central bank, which was made autonomous in the 1990s to insulate it from political pressure.

The central bank forecasts inflation to slow toward its 3 percent goal during the rest of this year and next, reaching that level in the first half of 2020. Inflation will be 4 percent in 2019, according to the median estimate of 30 analysts surveyed Bloomberg. Annual inflation climbed for four straight months to reach 5 percent in September and remained near that level in October.

Mexico’s 10-year breakeven rate, a bond market proxy for cost of living prospects during the next decade, climbed 0.5 percentage point in the past month, the most in Bloomberg data going back to 2012, to 4.92 percent.

--With assistance from Rafael Gayol and Justin Villamil.

To contact the reporter on this story: Eric Martin in Mexico City at emartin21@bloomberg.net

To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Robert Jameson, Philip Sanders

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