USD/MXN rallies from session lows under 20.50 as Banxico delivers widely expected 25bps rate hike

• USD/MXN has jumped from prior session lows under 20.50 to around 20.60 in wake of the Banxico policy decision.
• The bank raised interest rates by 25bps to 5.0%, though some expected a 50bps hike and one voter dovishly dissented.

USD/MXN has erased a substantial portion of its earlier losses in recent trade in wake of the Banxico’s decision to hike interest rates by 25bps as expected. The pair has bounced from close to session lows around 20.50 to current levels around 20.60 and currently trades with on the day losses of about 0.2%. USD/MXN saw a substantial rally on Wednesday as a result of broad USD strength in wake of a much hotter than expected US inflation report and currently trades with on-the-week gains of about 1.4%. Mexican Consumer Price Inflation data was also released earlier this week, also rising at a 6.2% YoY rate in October, though this was unable to result in sustained MXN strength, given that the Banxico is already well into a hiking cycle to maintain price stability.

Banxico hikes rates as expected

The Bank of Mexico raised its interest rate by 25bps as expected for a fourth consecutive policy meeting on Thursday, taking benchmark rates to 5.0%. The board voted four to one in favour of the rate hike, citing concerns about above actual inflation and inflation expectations that are above the bank’s 3.0% target. While the bank reiterated that it sees the shocks that have increased inflation recently to be largely transitory, it said that the balance of risks for the trajectory of inflation remained biased to the upside. Moreover, the bank said the horizon over which these shocks may affect inflation are unknown, thus posing a greater risk to the process of price formation and to inflation expectations. The bank adjusted higher its 2021 inflation forecast to 6.8% YoY in Q4, though left the end 2022 forecast unchanged at 3.3% YoY.

The initial reaction of MXN in response to the meeting was to weaken. Some analysts had predicted the bank would hike rates by 50bps, thus the move could reflect an unwind of some hawkish bets. Meanwhile, the fact that one voter dissented against the decision to hike interest rates diminishes the prospect for further rate hikes. The one dissenter was likely motivated by the fact that the Mexican economy likely contracted in Q3 2021, a fact acknowledged by Banxico, though the bank also stated that the economy was expected to resume its recovery in Q4 2021.

Speaking to Reuters on Monday, Latin America analysis director for Moody's Analytics Alfredo Coutino said that the bank should raise the benchmark interest rate to between 5.50% and 6.00% by the end of this year if it hopes to comply with its mandate to pursue stable prices. Thus, dovish descent at the latest rate decision may raise some fears that Banxico may fail to raise interest rates sufficient to tame inflation, a potential dovish mistake.