Dec 16, 2015

Dilemma for economy in thrall to Uncle Sam

Financial Times: Economic theory would suggest that you do not hike interest rates when inflation is at a record low. But that is precisely what Mexico is poised to do this week.

The Bank of Mexico, known as Banxico, faces the prospect of having to raise its historically low 3 per cent benchmark rate at a time when inflation has been setting record lows for each of the past seven months and when GDP growth, while the envy of many at 2.6 per cent, remains far below expectations.

For months now, Banxico has been priming the market to expect a rate rise when the Fed goes; indeed, it even altered its rate meeting calendar in July to be able to synchronise moves. But now that the time finally appears to have come for a US rate rise, the timing for Mexico may be less than ideal.

Many economists believe Banxico has little choice, because consumer prices are not the only indicator posting records in Mexico. The peso currency, which has slid more than 15 per cent against the dollar this year, hit another historic low last week, touching 17.44 per greenback. Failure to follow US rates up could pile more pressure on a currency pummelled by tumbling oil prices by encouraging bondholders to pile out of local assets to chase higher US yields.

“The bank will be playing with fire if they hold,” said Alonso Cervera at Credit Suisse in Mexico City. “The peso could tank and leave people wondering 'where's the bank’s commitment to the peso?',” he added.

He, like most in the market, expects a quarter-point rise from Banxico on December 17 — its first increase since mid-2008, when the bank hiked three times in three months to take the rate to 8.25 per cent.

Mexico’s benchmark rate has been at a historic low of 3 per cent since June 2014, when Banxico made a shock half-point cut, its fourth surprise cut in just over a year, to try to kick-start persistent flagging growth. third-quarter GDP growth of 2.6 per cent, which for once outperformed expectations, prompted official cheers but the government’s goal of 5 per cent growth by 2018 still looks hopelessly out of reach.

Indeed, despite robust domestic consumption, job growth and increased bank lending that have pushed growth to its fastest pace in two years, things are not all rosy. Data published last week showed industrial production grew by 0.5 per cent in October, its slowest pace for five months with manufacturing exports sluggish despite the cheaper peso.

Once runaway enthusiasm about Mexico’s prospects may have subsided into a boring holding pattern of gradual, if unexciting, improvement. But Mexico enjoys enviable economic and political stability compared with many emerging peers, notably Brazil, where recession and political turmoil are deepening by the day, and Argentina, where a bitter devaluation looks imminently on the cards. Boring, by comparison, is the new beautiful — and many economists see Mexico as one of the brightest emerging market stories in 2016.

Agustín Carstens, Banxico’s astute and respected president, has acknowledged Mexico's rate dilemma, telling Reuters in an interview earlier this month that “we are facing opposing forces”. Banxico — which has intervened to support the currency in recent months — had to be ready to “take care” of the peso, he said, while noting the Fed was not the only factor for Mexican monetary policy.

Despite the peso pressure, Marco Oviedo, economist at Barclays in Mexico City, believes that those other factors deserved to outweigh any Fed move next week.

“Short-term inflation expectations have declined . . . Unemployment has stalled and the economic recovery has not yet consolidated,” he noted. “Manufacturing is facing headwinds and public investment will likely not be a source of growth in the near term. “

If the Fed signals tightening will be gradual and markets take that in stride, he believes Banxico might have a breather not to hike. But a sharp reaction would mean Banxico would probably have to follow suit, he acknowledged.

Whatever happens, Mexico’s economy is intimately intertwined with that of the US, the destination for the bulk of its exports. A firmer US economy, as indicated by a Fed hike, can only bode well for Mexico.

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