Peso weakness has yet again left Mexican monetary policymakers in an unenviable position. Last Friday, the MXN fell to a record low of 19.77 to the dollar, leading to speculation that Banxico will be forced to intervene in the currency markets … or even into an emergency interest rate hike, similar to the inter-meeting move it made in February.

The currency’s slump — down 12 per cent year-to-date, making it the second-worst performer in developing markets after the Argentine peso — is due to a nasty confluence of factors. Its correlation with the electoral fortunes of Donald Trump has stolen the headlines and its role as a liquid proxy for EM assets generally does not help. But concerns over a rise in US interest rates, possibly as early as this week, and renewed weakness in oil markets are also in the mix. And underneath that are Mexico’s underperforming economy and rising political risk.

The interplay of these forces has created a conundrum for the central bank. It needs to reassert its control of foreign exchange markets and last Friday would have been a perfect opportunity for it to intervene in what looked like an unstable market — but Mexico’s Independence Day holiday prevented it from doing so.

So far this week, the peso has stabilised a bit, which makes FX intervention less likely, especially since the bank wants to preserve its firepower in case it needs to cushion the currency after a possible Trump victory. However, it will be carefully watching the pace of any further peso weakness.

Instead, the focus has shifted to monetary policy. Banxico has already raised rates by a full percentage point to 4.25 per cent this year, including the unexpected 50 basis point hike in February when peso volatility was similarly high. While another sudden move cannot be ruled out, Medley Global Advisors, a macro research service owned by the FT, reckons the bank will wait until its next meeting on September 29, especially since it will want to first see what the US Federal Reserve does this week.

If the Fed defers its own rate increase to December, as most now expect, and MXN holds above the symbolic level of 20 to the dollar, then Banxico may get away with doing nothing. That would be the preferred option: the last thing the struggling economy needs is another rate rise.

Growth is barely above 2 per cent this year, fiscal policy is also tightening and the rating agencies are warning of a possible downgrade. Politically too, the falling popularity of President Enrique Peña Nieto, who lost his finance minister following the public relations disaster of Mr Trump’s recent visit, would argue for Banxico to stay on the sidelines.

Complicating that picture is inflation. After little in the way of price pressures over the past couple of years, consumer price inflation rose 2.7 per cent year on year in August while producer price inflation was 5.6 per cent. And that is before the impact of the recent peso weakness. This is leading some to forecast that the central bank will opt for a compromise hike of 25 bps next week.

Of course, if the Fed does decide to raise rates, something rather stronger may be needed. But even if it does not, Banxico will have to assess whether there has been a permanent rise in Mexico’s risk premium and act accordingly.

Dan Bogler is a commissioning editor at Medley Global Advisors

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