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Mexican Peso Gains on Banxico’s Rate Hike Surprise and Hawkish Shift, USD/MXN Sinks

Mexican Peso Gains on Banxico’s Rate Hike Surprise and Hawkish Shift, USD/MXN Sinks

Diego Colman, Market Analyst

BANXICO RATE DECISION KEY POINTS:

  • Banxico increases its overnight rate by 25 bps to 4.25%, surprising investors
  • Rising inflationary pressures prompt the central bank to adopt a hawkish stance
  • The decision to tighten monetary policy unexpectedly boosts the Mexican peso against the US dollar
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The Bank of Mexico concluded this afternoon its June monetary policy meeting. The institution led by Alejandro Diaz de Leon surprised markets and increased the overnight interest rate by 25 basis points to 4.25%, reinforcing the MXN rally against the US dollar. The decision to unexpectedly raise borrowing costs and deviate from the “steady-hand” approach is a clear sign policymakers are growing uneasy about rising consumer prices in the economy.

The language in the press released took on a much more hawkish tone, a sign that aggressive policy normalization may be on the horizon. That said, on the economic recovery front, the central bank indicated that higher growth is expected for the rest of the year amid a more favorable outlook.

Meanwhile, on inflation, Banxico rang alarm bells and stated that consumer prices have risen more than foreseen and that convergence to the target will be delayed to the third quarter of 2022. Against this backdrop, the bank warned emphatically that the inflation balance of risks is biased to the upside (as a reminder, headline CPI in the first fortnight of June came in at 6.02% y-o-y, reaching a level significantly above Banxico's target of 3%, with a tolerance range of plus or minus 1 percentage point).

If you want to learn more about how central banks work, check out DailyFX Education

The bank’s hawkish shift may reinforce expectations that tightening will continue in the second half of the year to tame inflation. Market participants are pricing two more rate increases, but a third hike could be in the cards if the rise in consumer prices does not ease.

Monetary tightening could become a positive catalyst for the Mexican peso over the medium term, especially if the Fed delays till late summer or early fall its comprehensive tapering debate. For that reason, USD/MXN may continue to head lower as we enter the third quarter of the year.

USD/MXN 5 MINUTE CHART

USDMXN reaction post Banxico

Banxico’s decision triggered strong volatility and accelerated USD/MXN’s losses as investors started to position for the possibility of a lengthy tightening cycle in Mexico and a more attractive carry for MXN. In any case, the latest policy measure by the central bank appears to be taking a back seat as the market remains focused on US politics. Earlier today, President Biden announced his government secured an infrastructure investment compromise with a bipartisan Senate group. The package, which is worth around $1.2 trillion over eight years boosted risk appetite, lifting EM FX across the board.

EDUCATION TOOLS FOR TRADERS

---Written by Diego Colman, DailyFX Market Strategist

Follow me on Twitter: @DColmanFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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