According to Eugenio J. Alemán, Senior Economist and Erik Nelson, Economic Analyst from Wells Fargo, if inflation continues to rise faster than Bank of Mexico (Banxico) expects, it may be forced to hike rates at a more brisk pace that what is currently price in. Key Quotes: “Mexico’s central bank (Banxico) surprised markets on February 17 when it announced an unscheduled 50 bps increase in its policy interest rate target. This move marked a stark divergence from other recent Banxico policy decisions which had previously been highly dependent on antecedent policy moves from the U.S. Federal Reserve. Policymakers cited the persistent depreciation of the Mexican peso as the primary reason for the move, noting that further downward pressure could cause inflation expectations to become unanchored.” “However, inflation spiked in the first two months of the year, and our econometric results suggest that the lagged impact of past peso depreciation can have a more significant impact on inflation than depreciation in the current period. Should inflation continue to rise faster than Banxico policymakers expect, they may be forced to hike rates at a more brisk pace than markets are currently pricing in.” “One of the consequences of this relationship is that Mexico’s monetary policy has been highly dependent on the stance of monetary policy being conducted north of the border. This does not necessarily mean that every time the Fed moves, Banxico follows suit. Instead, monetary policy decisions in the United States are likely taken into account by Banxico policymakers as they mull their own policy decisions. Indeed, Banxico’s decision last year to hold its monetary policy meetings a day after Fed meetings was a fairly explicit signal that the two central banks’ policies would likely closely follow one another.” “For many months, markets had been wondering why Mexican consumer prices were not reacting to the significant depreciation of the Mexican peso and were trying to figure out if “this time was different.” Now, it will be a battle against potentially unsettled inflation expectations, with the risk that the Mexican central bank may already be behind the curve.” “Policymakers were careful to note in their statement that the surprise rate hike was not the beginning of a tightening cycle, but if inflation continues to rise ahead of central bank expectations, Banxico may be forced to raise rates faster than markets, as well as its own policymakers, currently expect.” For more information, read our latest forex news.