(Bloomberg) -- Argentina investors say the central bank’s extraordinary effort to bolster the peso Friday may be just the beginning, with more such actions to be expected if the currency doesn’t stabilize soon.
Policy makers’ decision to raise the key interest rate 3 percentage points to 30.25 percent Friday, a surprise move announced just days after they held borrowing costs, led the peso to erase losses for the day. Should the currency resume the sharp selloff it saw in recent days, the central bank is likely to hike again, according to strategists at TCW Group and Barclays Plc.
“The rate should be enough to keep the foreign-exchange dynamics stable," said Mauro Roca, the managing director for emerging markets sovereign research at TCW Group. "But any short-term decisions will be tied to whatever happens in the FX market."
The central bank is seeking to reestablish its credibility after sending mixed signals to investors earlier this year, when policy makers pared back their goals for cutting inflation and lowered borrowing costs in a bid to spur growth.
Now, after spending $4.3 billion this week alone to bolster the peso in the spot market and taking the highly unusual step of raising rates at an unscheduled meeting, policy makers are showing their determination to keep a lid on consumer-price increases, which will require a stable exchange rate.
The peso was headed to its worst weekly drop in almost a year when the bank acted Friday, and its 10 percent loss in 2018 has made it the worst preforming major currency. But the decision to hike rates was a key reversal after the press conference that announced the revision of inflation targets from more stringent goals suggested that the central bank was politically restricted from raising rates, Roca added.
To Barclay’s Latin America economist Pilar Tavella, downward pressure on the peso due to "global conditions remaining unsupportive of EM or negative local political developments" may lead the bank to hike again. Argentina’s exchange market will remain closed April 30 and May 1 amid national holidays. Peso performance will be the main indicator to watch ahead of the next monetary policy decision to be held May 8, a week before inflation data for April are released May 15.
The central bank has insisted that the FX weakness has been "transitory" and that inflation will drop in the second half of the year, after the effect of rises in regulated price increases are past. Inflation should really begin dropping after June, said Soledad Lopez, emerging markets strategist at UBS Global Wealth Management’s chief investment office, who expects the bank to stay on hold until then.
While the move was heralded by some as a full-deployment of the central bank’s tools to manage monetary policy in Argentina, detractors remain of managing the currency using the key rate. David Kotok, founder and chief investment officer at Cumberland Advisors, pointed to a rate hike by U.S. Federal Reserve Chairman Alan Greenspan in 1987 aimed at defending the dollar that spooked investors and led to a market crash as a lesson worth remembering.
"I worry when I see the use of interest rates as a surprise vehicle to maneuver the FX market," he said. "History shows that trying to use a domestic interest rate to solve a global pricing issue is a mistake. There are no notable exceptions -- Greenspan learned that in 1987 in the U.S. I hope my Argentine friends don’t have to pay a similar price."
Argentine investors looking ahead to a decision by index provider MSCI Inc. to upgrade stocks to emerging market status from frontier market should stay calm amid FX movements, as the changes are "circumstantial" and don’t reflect structural openness, as would something like capital controls, Lopez said.
The main challenge for Argentine President Mauricio Macri will now be to keep local retail investors calm and avoid a run on the peso -- Argentines tend to flock to greenbacks given the country’s history of hyperinflation crises and bank deposit confiscations that have undercut confidence in the currency, according to analysts as Balanz Capital Valores SA in Buenos Aires.
"Until the global fixed income universe enters into another violent spasm, today’s rate decision should be viewed as a powerful anesthetic that should put the currency on a more stable path while the BCRA navigates the “ring of fire” of second round inflation effects from the regulatory price hikes," they wrote, led by Walter Stoeppelwerth. "To minimize the risk for the peso in coming months, the BCRA has to make sure that the local investors, not hedge funds, are pacified."
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