Mexico's central bank, Banco de México, decided Dec. 15 to raise its benchmark interest rate by 50 basis points to 5.75%, citing inflationary pressures, the potential impact of U.S. trade policies on the Mexican economy, and the U.S. Fed's recent decision to raise its benchmark rate by 25 basis points.
This is Banxico's fifth rate hike so far in 2016 after its most recent increase in November, which was also by 50 basis points. This time, however, analysts had expected a lower increase; a Reuters poll before the hike had predicted the bank would raise its benchmark rate by the same amount as the Fed.
In its decision, Banxico admitted that volatility in global financial markets has fallen since the days following the U.S. election, and the Mexican peso has appreciated slightly against the U.S. dollar, but noted that the exchange rate and interest rates remain higher than before the election.
Globally, the expansionary monetary policy in the U.S., and that country's solid economic performance, has helped drive an economic recovery in late 2016 that could continue into 2017, Banxico said. However, the recent surge in the strength of the U.S. dollar against nearly all currencies has increased inflationary pressures, the bank added.
Back in Mexico, despite signs of a moderate economic recovery in the third quarter thanks to stronger external demand, investment has stagnated and some indicators, such as trade and manufacturing data, suggest an economic slowdown in the last few months of 2016.
In this context, internal demand has not significantly affected prices while external risks associated with President-elect Donald Trump's win, mainly in terms of possible U.S. trade and immigration policies, have increased.
Inflation is also gradually rising. Mexico's annual inflation reached 3.3% in November, and the inflation outlook for 2016 and 2017 has increased above the bank's target of 3%, mainly due to the effect of the peso's depreciation on prices, the bank noted.
In this scenario, Mexican authorities should look to continue with fiscal consolidation efforts and structural reforms, including in the energy sector, the bank said.
Finally, the bank said it will continue to monitor the impact of the exchange rate on inflation, as well as monetary policy rates in the U.S., especially since the Fed is expected to continue its monetary policy normalization process "at a faster rate" in 2017.