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Mexico’s central bank increased its key lending rate on Thursday as expected by 50 basis points to 6.25 per cent after January inflation jumped to an 18-year high, fuelled by a sharp rise in gasoline prices.

It was the sixth time in a row that the Bank of Mexico has pushed up borrowing costs by half a point in a bid to cool inflation and prevent the peso – which has weakened around 12 per cent since Donald Trump’s election as US president – from piling further pressure on prices, writes Jude Webber in Miami.

Mexico’s state statistics office earlier on Thursday reported a higher-than-expected 1.7 per cent rise in consumer prices in January, reflecting the government’s decision to end regulated fuel prices. That pushed the annual inflation rate to 4.72 per cent – well outside the central bank’s target of 3 per cent, plus or minus 1 percentage point.

“The inflation figures suggest a deterioration of the inflation outlook and some generalisation of inflationary pressures into services and other core components,” Alberto Ramos at Goldman Sachs wrote in a note ahead of the rise. The backdrop of the peso’s steady fall over the past year, slowing growth and rising inflation “fully justifies” an interest-rate shift, he added.

But the central bank nonetheless faces a fine balancing act. Economic confidence indicators have weakened recently and rising rates will start to bite into activity and employment. A recent poll by Citibanamex forecast an average 1.4 per cent growth in 2017 GDP, a sharp slowdown from the nearly 2.3 per cent growth last year indicated by preliminary data.

In addition, the peso has clawed back some of the ground it lost after Mr Trump’s win in November and has steadied in the past couple of weeks.

As a result, “the central bank needs to react in order to limit second-round effects and anchor inflation expectations, but does not need to overreact … particularly when taking into consideration that … there are still important challenges ahead that may require a forceful monetary response,” Mr Ramos said.

Michel Del Buono, global strategist and managing director at Makena Capital Management, added that “because of the pass-through from the currency changes, [policymakers] didn’t have much choice.”

Mr Trump’s policies towards Mexico remain unclear. He wants to rewrite the North American Free Trade Agreement so that it is more favourable to the US and has vowed to pull the US out unless he can do so.

More than 80 per cent of Mexican exports go to the US, making Mexico’s economy vulnerable to any shocks from the north. Months of uncertainty lie ahead as face-to-face negotiations between the US and Mexico on the future of Nafta will not start before May.

The central bank said it would monitor all inflationary factors very closely, especially potential pass-through from inflation and fuel prices and the peso’s performance against the dollar in order to “continue taking all necessary measures to achieve efficient convergence of inflation to the 3 per cent target”.

“It’s a very challenging situation … they’re in a tough spot, but [Banxico] did absolutely the right thing,” said Gustavo Rangel, chief economist for Latin America at ING. He saw little extra room for fiscal measures – the government has already announced an austerity drive and is committed to not raising taxes – so he saw further interest rate rises on the cards, to end the year close to 7.5 per cent.

“It’s really a bit of a perfect storm for Mexico,” he added, noting that lower income from oil and lower oil production also complicated the picture. “It’s not all about Trump, but it’s all coming together at the same time.”

But Linda Lim, professor of strategy at the University of Michigan’s Ross School of Business, said higher rates risked tipping Mexico into recession and may do little to stem the fall of the peso, “and if higher interest rates do stop the peso from sliding, this will also deprive Mexico of its only market-determined defense against President Trump’s trade attack – i.e., to keep getting cheaper and cheaper with the weakening peso”.

Copyright The Financial Times Limited 2017. All rights reserved.
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