Mexico's Central Bank Hold Rates, Steps Up Peso Defense

By Juan Montes 

        MEXICO CITY--The Bank of Mexico stood pat on rates Thursday for a ninth consecutive meeting in a moment of slow economic growth and low inflation, while authorities took new measures to support a weak peso through increased dollar auctions.
        The foreign exchange commission, formed by officials of the central bank and the Finance Ministry, said it's increasing the amount of dollars to be sold at auctions to address continued exchange market volatility.
        The peso reacted immediately, appreciating around 1.2% against the U.S. dollar. In early trading, the peso hit a new all-time low against the greenback, after the U.S. economy accelerated in the second quarter, increasing chances of a Federal Reserve rate increase in September.
        The Mexican peso, the world's most traded emerging market currency, has taken a hit in recent months from the expected Fed move, as higher returns in the U.S. would make the dollar more attractive for investors than riskier currencies.
        The central bank's policy statement said "possible monetary policy action from the Federal Reserve could have additional impact on the exchange rate." The bank said it's paying particular attention to the exchange rate and the Fed's monetary stance.
        But the Bank of Mexico stopped short of raising interest rates before the Fed, and kept the overnight lending rate at a record-low 3% to keep supporting an economy that has been slowing this year. Policy makers had ruled out a pre-emptive rate hike.
        The central bank said Thursday that the outlook for growth has worsened in the last months. Economic growth in May, the latest data available, was just 0.1%, with industrial production contracting and household consumption only marginally recovering.
        Instead, authorities are trying to support the peso through dollar auctions.
        Starting Friday, and at least through the end of September, the central bank will raise to $200 million from $52 million the amount of dollars it sells each day. The commission also reduced to 1% from 1.5% the amount the peso has to weaken for the central bank to sell an additional $200 million. Since December, the central bank has sold $5.7 billion in dollar auctions.
        The commission said Mexico has adequate foreign reserves as well as a $70 billion flexible credit line with the International Monetary Fund, and could take further actions if necessary. Foreign reserves stood at $191 billion last week.
        The central bank is widely expected to start raising interest rates in September if the U.S. Federal Reserve does, to avoid further depreciation of the peso and a resulting rise in inflation expectations.
        The economic slowdown has limited any inflationary impact that a weak peso could have through more expensive imports. Annual inflation hit its lowest level since 1970 at 2.76% in early July, well below the central bank's 3% target.
        With inflation at historically low levels and the economy moving at a slow pace, only a weak peso has prevented further monetary easing. The bank's last move was a rate cut in June of 2014.
        The main goal of Mexico's central bank is to control inflation, and to guarantee stability in the purchasing power of the peso. Gov. Agustin Carstens has said that despite the 20% depreciation of the peso in the past year, markets have been functioning orderly most of the time.
        In Thursday's policy decision, the central bank's s five-member board said the manufacturing non-auto sector, the core of Mexico's export engine, as well as the construction and mining sectors, are still weak.
        Mexico has been hurt by lower oil production, which has fallen 8% in the past year, and the 50% drop in oil prices. Lower oil revenue forced the Mexican government to cut $8.3 billion in spending this year to protect public finances, which is expected to further hurt the economy.
        The central bank said inflation is well-anchored and expected to remain below 3% the rest of the year. The bank said the recent peso depreciation has only partially affected some nonfood goods, with no spillover effect on other prices.
        Write to Juan Montes at juan.montes@wsj.com
        (END) Dow Jones Newswires

        July 30, 2015 15:26 ET (19:26 GMT)

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