Mexican Peso Gains after Banxico Front-Loads Rate Hikes, USD/MXN Sinks

BANXICO KEY POINTS:

• Banxico surprises investors and increases the overnight rate by 50 bp to 5.50%
• The hawkish hike boosts the Mexican peso, driving USD/MXN to its lowest level since November 19
• The statement suggests policymakers may continue to raise borrowing costs in 2022, but the situation should be reassessed next year as the central bank will get a new governor

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Banxico took an aggressive step and front-loaded rate hikes at its December monetary policy meeting to combat mounting price pressures in the economy and upside risks to the inflation profile. At the end of the gathering, one day after Fed made a hawkish shift, the institution’s governing board opted to raise the overnight interbank rate by 50 basis points to 5.50%, surprising investors who had only anticipated a quarter-point adjustment.

The Mexican central bank has been tightening policy steadily since June, increasing borrowing costs at every meeting, taking the total cumulative increase in 2021 to 150 basis points amid red-hot CPI, which hit 7.37% y/y in November, its highest level in over two decades and more than twice the target of 3%.

In the statement, Banxico indicated that medium-term core and headline inflation expectations have risen and that forecasts have been revised upwards (see table below), especially for the upcoming year. At the same time, policymakers also acknowledged that the balance of risks for the trajectory of inflation has deteriorated further and remains biased to the upside, a message that leaves the door open to additional rate increases in 2022 if the outlook for consumer prices worsens.

BANXICO INFLATION FORECASTS

Source: Banxico

USD/MXN REACTION

Banxico’s hawkish hike triggered a bullish reaction in the Mexican peso, briefly driving the USD/MXN to 20.76, its lowest level since November 19, though broad-based risk aversion limited the U.S. dollar downside.In any case, the likelihood that monetary policy will become more restrictive in Mexico in order to tame inflationary forces can be seen as a positive catalyst for the Latin American currency, but traders should reassess the situation next month after the bank completes its leadership transition. As a reminder, Victoria Rodriguez Ceja, a close ally of the President and little-known public sector economist, is poised to become the central bank’s new governor in January. At this time, it is hard to say in what direction Rodriguez will steer the institution, but the outcome will have far-reaching implications for Mexican financial assets.

USD/MXN 3 MINUTE CHART

USD/MXN chart prepared in TradingView

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—Written by Diego Colman, Contributor