Firm peso should alleviate concerns about inflation pass-through in Mexico

Mexico’s central bank (Banxico) held the overnight rate at 3.75 percent on Friday March 18th as expected after it surprised markets at its February 17 meet when it announced an unscheduled 50 bps increase in its policy interest rate target.

The peso has responded well to the Feb tightening, strengthening against most among major currencies. The central bank said it will pay special attention to the exchange rate and its possible pass-through to consumer prices, while a faster peso appreciation could lower inflation. That appreciation opens the door for the central bank to return to its previous strategy of pairing rate increases with the Fed.

"It’s a bit of a victory lap, that the measures announced Feb. 17 were very effective in anchoring the currency. If the currency remains well anchored, if there is no evidence of significant pass-through to domestic prices, they will match whatever the Fed does over the next meetings." said Alberto Ramos, chief Latin America economist at Goldman Sachs in New York.

Mexico's inflation spiked in the first two months of the year and if it continues to rise ahead of central bank expectations, Banxico may be forced to raise rates faster than markets expect. A firm peso should alleviate some concerns about inflation pass-through. Rising inflation should justify a cautious stance for the central bank at its next policy meet.