Mexico is highly likely to raise interest rates later this week, as the country’s currency peso plunged to record lows in the global market volatility sparked by the Britain’s decision to leave the European Union.
As the “Brexit” (British exit) became clear on Friday, the peso sank 7.1% to hit a new record low of 19.5187 against the U.S. dollar. The day’s decline took the currency’s loss this year to nearly 10%, making it the second worst performing major emerging market currency after the Argentine peso.
This sharp plunge in the wake of Brexit has left the Mexican government worried, with the country’s Finance Minister, Luis Videgaray, saying that the central bank would act to make the currency stable. Soon after, the government announced that it would cut federal spending by US$1.68 billion, its second such cut this year, in order to reassure investors and help keep its borrowing costs down.
Central banks normally raise interest rates to push down inflation, but in Mexico inflation is not running high and stands at 2.55%, according to data released a week ago. Officials say the prolonged weakness in currency would drive up inflation.
Interestingly, the peso’s decline has been blamed on speculators. “The Mexican peso is often used by investors as a proxy for less liquid emerging market currencies,” explains Financial Times. “This makes it vulnerable to large sell-offs during times of stress as a hedge against long positions in emerging markets.”
This is precisely why the Mexican central bank said it was ready to intervene in the exchange markets if it saw speculators had singled out the country’s currency. Of the 18 analysts surveyed by Bloomberg, 10 now expect the Mexican central bank to raise benchmark rates by either 25 or 50 basis points.
Mexican currency as well as its capital market benefited greatly after the United States and the European Union kept their interest rates at a record low for a prolonged period. But analysts warn that these inflows turn into outflows when global market plunges into turmoil.