Category: Corporate & Sovereign Strategy

Mexico has jacked up its policy rate by 25bp to 8.00% in an attempt to stamp out inflation, building on a 25bp rate hike enacted in June. This was in line with consensus and the post meeting communique is viewed as broadly neutral. The central bank adds that it will revise its inflation projections July 30 by approximately 50bp on average. The yield curve moved up by 12bp-15bp across the board, says Credit Suisse. “We would not expect another rate hike in August, unless inflation expectations worsen materially. For the balance of the year, we expect just one more rate hike of 25bp,” adds the shop. “We continue to expect Banxico to hike the overnight rate a further 25bp, to 8.25%, this quarter,” says Barclays. Others expect a pause. “We expect the central bank to leave the TdF unchanged at 8.00% until June 2009 as there are no demand-pull pressures on inflation and the balance of risk on growth has deteriorated,” says Goldman Sachs. “If, by the end of 1H2009, actual and expected inflation are converging toward 3.5% (i.e. the middle of inflation target upper half band) then we see the possibility that Banxico could initiate a monetary easing cycle involving three cuts of 25bp apiece, pushing the policy rate to 7.25% by end 2009,” it adds.

The market is betting on another 25bp rate hike from Mexico Friday, but Credit Suisse predicts that Banxico will wait. “We maintain our view that the central bank of Mexico (Banxico) is likely to leave the overnight rate unchanged at 7.75% in this Friday’s (18 July) policy announcement,” says Credit Suisse. “The central bank will choose to leave rates unchanged this time around and tighten instead by 25bp in the 15 August policy announcement,” it adds. The shop expects Banxico July 30 to raise its inflation forecast for Q4 by as much as 75bp, from 4.25%-4.75%, leading to pressure to continue to increase the overnight rate. “The central bank is not about to embark on a prolonged tightening cycle; instead, we see it choosing the timing of its rate hikes selectively,” says Credit Suisse. Thus Banxico would look to avoid signaling a long tightening cycle by sitting out an announcement.

Looking ahead, Peru’s central bank still has room for more monetary tightening, says Alfredo Coutino, senior economist at Moody’s. Last week, it raised the benchmark rate to 6.00% from 5.75%, and will likely continue on this path to avoid a deterioration in inflation expectations. “It should not be a surprise to see one or two more hikes in the reminder of the year,” says Coutino. The economist says the central bank acted appropriately last week. “The central bank’s monetary action is justified, particularly because monetary conditions continue to be expansionary, with the interest rate still staying below neutrality.” Inflation has picked up in Peru, reaching 5.7% in June, nearly tripling its mid-point target of 2%.

Following last week’s surprise Mexican rate hike, which dragged down stocks, analysts anticipate further monetary tightening this year. Banxico raised the overnight rate by 25bp to 7.75% Friday, its first change since October. “We do not view this as the start of a long tightening cycle and we tend to think that the bank may require less of a tightening than the curve is currently pricing in (50bp in six months),” says Credit Suisse. Morgan Stanley meanwhile revised its prediction for the year-end rate to 8.00% from 7.50% previously. “Hiking interest rates in Mexico today is akin to buying fire insurance: the subsequent absence of a fire is hardly valid criticism of the decision to purchase insurance in the first place,” adds the shop, rejecting criticism of the move at a time of slower growth. Morgan Stanley also adjusted upward its Mexico inflation forecast for 2008 to 4.3% from 3.8% and for 2009 to 3.5% from 3.3%. Inflation has been on an upward trend since the start of the year, rising from 3.70% in January to 5.00% in May, mostly caused by the effect of high international prices for food and energy.