Will Banco de Mexico raise the Reference Rate?

Between the unexpectedly high inflation rate in the first half of January and the market turmoil, the odds that Banco de Mexico will wait until 2015 to raise the Reference Rate are falling. The inflation rate alone would not cause Banxico to raise the Reference Rate since there’s hope that price increases will have been frontloaded more than had been anticipated. However, the contagion effect from the “Fragile Five” complicates the situation.

To combat the flight from their currencies, the Five have raised interest rates. Turkey has been the most aggressive, boosting its benchmark rate from 4.50% to 10.00% on January 28; the overnight lending rate the climbed from 7.75% to 12.00%. India’s central bank raised the country’s key interest rate from 7.75% to 8.00% the same day and also announced that it will adopt a monetary policy to target inflation (an objective of 6% by 2016) whether the government is in agreement or not. The South African and Brazilian central banks both raised interest rates half a percentage point in January. On the 15^th, Brazil set the rate at 10.50%. On the 29^th, South Africa’s rate moved up to 5.5%. Indonesia is the outlier. Although the central bank hasn’t raised rates this month, it did surprise the markets in November when it raised the rate from 7.25% to 7.50%.

In their January 29 monetary policy announcement, Banco de Mexico’s Board of Governors defied the trend in which emerging markets’ central banks have raised key interest rates. The Board left the Reference Rate at 3.50%, where it has been since October 25, 2013. However, the Governors cautioned that the balance of risks has deteriorated and are watching for signs that inflationary expectations are rising or that the depreciation we’ve seen is feeding through to inflation. If that happens, the only surprise would be if if they don't raise the Reference Rate this year.