June 30, 2016 / 6:42 PM / in 2 years

UPDATE 3-Mexico cenbank raises rate aggressively to counter peso slump

(Adds economist comments)

By Michael O’Boyle and Gabriel Stargardter

MEXICO CITY, June 30 (Reuters) - Mexico’s central bank raised its key interest rate more than expected on Thursday in a bid to support the peso and calm concerns that currency weakness could inflame inflation.

The Banco de Mexico raised its key rate by half a percentage point to 4.25 percent, above the 25 basis-point hike projected by the median of analysts surveyed by Reuters.

The peso has been buffeted by global volatility since May and is the second-worst-performing emerging market currency this year, behind the Argentine peso. It reversed losses to gain around 1 percent after Thursday’s announcement.

Policymakers said they hiked rates to prevent deep peso losses from hitting inflation expectations after “external conditions deteriorated in a significant way.”

“I wouldn’t rule out that they could hike again, even before the Fed, if the exchange rate keeps trading very poorly,” said Benito Berber, an analyst at Nomura in New York.

The U.S. Federal Reserve Bank set aside a possible rate hike earlier this month, and many analysts now expect the Fed will keep rates on hold until late this year, if not longer.

Sergio Luna, an economist at Banamex in Mexico City, noted that policymakers did not say the hike was a one-off increase as they did in February when they raised interest rates by 50 basis points in an unscheduled meeting after the peso tumbled.

“They left the door open, maintaining a hawkish tone in a sense,” said Luna, one of the five banks expecting a 50-basis-point hike in the Reuters poll.

The central bank said the balance of risks for both inflation and economic growth had deteriorated, even though the inflation outlook was congruent with its 3 percent target.

Mexico’s peso slumped more than 7 percent against the dollar in May, its worst monthly loss in four years, and last week’s surprise vote by the United Kingdom to leave the European Union drove the currency to a record low.

Policymakers fear that peso losses could drive foreign holders of local currency debt to dump bonds, sparking a mass exodus that would hammer the peso and raise the risk of an impact on inflation.

Strategists at Mexican bank Banorte said they expected the market would pressure the central bank for further increases if the peso keeps weakening.

“In order to achieve any reaction in the local markets, from now on Banxico will need to hike 50 basis points,” Banorte said in a note, saying it has revised its outlook to half-percentage point increases in September and December, which would take the benchmark rate to 5.25 percent by the end of the year. (Additional reporting by Jean Luis Arce and Miguel Angel Gutierrez; Editing by Simon Gardner and Leslie Adler)

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