By Anthony Esposito
MEXICO CITY (Reuters) - The Bank of Mexico's board decided by a majority on Thursday to raise the benchmark interest rate by 25 basis points to 4.25%, saying it was necessary to avoid adverse effects on inflation expectations and citing price formation in the United States.
Three of the bank's board members voted for the hike, while two members voted to leave the rate unchanged at 4.0%. The surprise decision follows a hawkish tilt from the U.S. Federal Reserve last week, which signaled higher rates could come sooner than previously planned.
Some market observers had speculated that changes implemented on the board of Banxico since 2018 had made it less inclined to move quickly despite stubbornly high inflation.
"It wasn’t the best management of market expectations, but the hike was necessary to anchor inflation expectations," Joel Virgen, an independent analyst who previously was chief economist for Mexico at Citibanamex and BNP Paribas (OTC:BNPQY), said on Twitter.
Mexican consumer prices rose 6.02% in the year through the first half of June, well above Banxico's target of 3% plus or minus one percentage point, data from the INEGI national statistics agency showed earlier in the day.
"In this context, it was deemed necessary to strengthen the monetary policy stance in order to avoid adverse effects on inflation expectations, attain an orderly adjustment of relative prices, and enable the convergence of inflation to the 3% target," Banxico said.
Mexico's peso extended gains after the unexpected rate hike and was up as much as 2% on the day versus the U.S. dollar.
The bank said the balance of risks for inflation is biased to the upside and that headline inflation is now expected to converge to its target during the third quarter of 2022.
Since 2019, the bank had cut interest rates by 425 basis points, as the economy contracted even before the COVID-19 pandemic hit. It had kept the rate on hold at 4.0% over the last two meetings before Thursday's surprise move.
"Signaling is for Wimps! No Signal, No Hesitation, No Fear of a Market Surprise," said Goldman Sachs (NYSE:GS) economist Alberto Ramos, noting that Banxico did not say more rate hikes are coming, but did not rule them out either.
Additional negative inflation surprises, a deterioration of inflation expectations, or further hawkish shifts on U.S. Fed guidance, will most likely be met by additional moderate rate hikes in Mexico, Ramos said.
On growth, Banxico noted the Mexican economy recovered notably in March and moderately in April, and was expected to resume its recovery during the rest of the year, with an "equilibrated" balance of risks and slack conditions for the economy as a whole.
Ratings agency S&P on Thursday raised its forecasts for Mexico's economic growth to 5.8% for this year and 2.9% in 2022, saying Latin America's second-largest economy was benefiting from a strong U.S. recovery, via manufacturing exports and remittances.
S&P said Mexico's economic recovery would likely be uneven as stimulus measures to offset the pandemic's impact have been lacking, at only about 1% of GDP in 2020, and the ensuing damage to small and medium enterprises was relatively large.
Mexico's President Andres Manuel Lopez Obrador recently forecast that by the third quarter the Mexican economy will reach pre-pandemic levels, after gross domestic product contracted by some 8.5% last year driven by pandemic-related fallout.