UPDATE 2-Following Fed, Chile’s central bank hikes interest rate

23 Dec 2015 | Author: | No comments yet »

Mexico raises key rate for first time since 2008.

Mexico City • Mexico raised borrowing costs for the first time since 2008 following Wednesday’s increase by the Federal Reserve amid concern a smaller rate advantage versus the U.S. could lead investors to pull funds from Latin America’s second- largest economy.Even after Federal Reserve chair Janet Yellen and colleagues raised the target range for the federal funds rate to 0.25% to 0.5%, that’s still way below its 2% average since 2000 and the 3.2% of 2000 to 2007.

Banco de Mexico’s board, led by Governor Agustin Carstens, boosted the overnight rate 0.25 percentage point to 3.25 percent Thursday from a record-low 3 percent, as forecast by 21 of the 26 economists surveyed by Bloomberg. Agustín Carstens, who also chairs the policy advisory committee of the International Monetary Fund, said Thursday the orderly reaction so far in emerging markets to the U.S. It also means JPMorgan Chase & Co.’s average rate for eight developed nations and the euro-area weighted by size is on course to end 2016 at just 0.36%.

Federal Reserve’s rate increase could be sustained, noting that the coming moves will likely be less transcendental. “A very important thing is that this first step taken by the Fed had taken on a mystical quality, but I think that in subsequent actions taken by the Fed that characterization won’t apply,” said Mr. If the Fed lifts its benchmark to 1.5% a year from now, as JPMorgan predicts, the bank’s economists still see the rate for the key industrial economies undershooting 1% next December as the European Central Bank and Bank of Japan stay on hold. Mexican policymakers have been concerned that the long- awaited rate liftoff in the United States, Mexico’s primary trade partner and the world’s largest economy, could lead to capital outflows and financial instability in their country. The upshot for the world economy is, as Bank of England governor Mark Carney described this week, an environment of “low for long” rates even with the Fed hiking. Carstens said the Fed managed quite well its first rate increase in almost a decade, explaining ahead of time and in detail what it intended to do, which contributed to an orderly reaction in many emerging market currencies.

The central bank has spent about $24 billion in 2015 on intervention programs to support the currency. “The central bank has been watching the Fed very closely and preparing the market for this. The peso, the world’s eighth most-traded currency with a daily volume of $135 billion, strengthened after the widely anticipated Fed decision and closed little changed Thursday at 17.06 per dollar.

Other Latin American currencies, such as the Brazilian real, have also strengthened. “I think that for the time being the solid response can be sustained, but there is constant news that could have an impact on markets,” Mr. Thursday’s rate increase brings to an end an almost seven-year period beginning with Carstens’s predecessor, Guillermo Ortiz, in which Banxico cut rates 11 times as the economy struggled with the global financial crisis and its aftermath. Many economists anticipated that Mexico would follow the Fed after Banxico in July changed its meeting schedule for the rest of 2015 to be able to better react to U.S. moves.

On Thursday, the Bank of Mexico raised its overnight interest-rate target by 25 basis points to 3.25%, as widely expected, in a move that most analysts saw as inevitable after the U.S. It signaled that the pace of subsequent increases will be “gradual.” The peso plunged 23 percent in the past year and a half through Wednesday, reflecting the decline in oil prices and expectations for higher U.S. borrowing costs.

Carstens, who ran unsuccessfully in 2011 to head the IMF and has left the door open to try again next year when Christine Lagarde’s term ends, praised the Fed’s handling of a process of monetary normalization that will gradually end the age of easy money that started after the 2008 financial crash. “The Fed is acting in a way that’s congruent with its mandate and with the communications it has been carrying out for many months. With the Fed’s balance sheet now around 25% of gross domestic product, it estimates the ECB’s will reach 33.8% by May 2017 and the BoJ’s will rise to almost 108% of GDP by the end of that year. “A sizeable amount of liquidity will be added to global markets over the next two years, if not longer, even as some central banks slowly hike rates,” Michael Hanson, an economist at BofA, said in a report this month. “This combination should help to maintain a very accommodative policy stance globally, which in turn should give a lift to global growth, help put a floor under inflation, and support demand for risky assets—all the while keeping a lid on longer-term bond yields.” Unconvinced is Steve Barrow, head of Group-of-10 strategy at Standard Bank Group Ltd in London, who argues the world is at an “inflection point”. Rate cuts and bond-buying elsewhere don’t wield the same heft as those from the Fed because the dollar remains the prime international currency and its set to stay strong, he said. “The bottom line is that weaning the world off the Fed’s monetary largesse is going to be hard, even if does not seem this way initially,” said Barrow. “We’d be prepared for higher volatility and a higher dollar, but lower prices for risk assets.” If the US does slip back into recession at some point, rock-bottom rates will also again be the order of the day, former US treasury secretary Lawrence Summers told Bloomberg this week in giving odds of 50-50 that such a slump will occur within two years. The bank raised rates in a bid to keep the peso competitive, but annual inflation is at 2.2%, the lowest level in 45 years, and economic growth remains moderate.

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