Mexico central bank hikes rates to over seven-year high as U.S. election sinks peso

MEXICO CITY (Reuters) - Mexico’s central bank hiked interest rates to their highest in over 7 years on Thursday and warned that the election of Donald Trump as U.S. president had cast doubt on the direction of Latin America’s second-largest economy.

Mexican pesos and U.S. dollar banknotes are seen in this picture illustration, November 3, 2016. REUTERS/Edgard Garrido

The Banco de Mexico raised its key rate MXCBIR=ECI 50 basis points (bps) to 5.25 percent, its highest since May 2009.

The move had been expected by the median of 15 analysts polled by Reuters from the end of last week. But the market later tilted toward a hike of at least 75 bps and the peso MXN=MXN=D2 closed down just over 1 percent.

“The market was expecting a bit more,” said Alfonso Esparza, a strategist at Oanda in Toronto, who still thought the 50 bps hike was the right move due to the risk to growth from Trump’s threat to unwind a free trade deal with Mexico.

“It is still very early to know what could be the effect of the new policies of President-elect Trump,” he said. “The central bank could end up risking too much before it really knows what will happen with Trump’s promises.”

The central bank said the outcome of the U.S. election could affect the relationship with Mexico, on top of further episodes of global volatility.

“The current environment facing the national economy is characterized by greater uncertainty,” it said, adding that “the new international environment” suggested that economic growth could be weaker going forward.

The peso slid to a record low last week as Trump swept to power, posting its biggest two-day loss since a 1995 devaluation. The currency shed more than 8 percent for the week, with the dollar soaring past 20 pesos per dollar.

The Republican candidate had threatened during the election campaign to unwind a free trade deal with Mexico and block the money sent home by migrants to pay for a border wall.

The central bank insisted Mexican banks were well capitalized, but that the government should take further steps to improve economic fundamentals.

On Thursday evening, Central Bank Governor Agustin Carstens said after an event with Finance Minister Jose Antonio Meade that the bank would work to keep those fundamentals solid “because this is key to anchoring the exchange rate.”

The peso’s deep slump could fan inflation.

In its statement on Thursday, the central bank said the outlook for inflation had gotten worse, noting that inflation would likely rise about its 3 percent target next year.

Mexico’s annual inflation rate rose past 3 percent in October for the first time in over a year and a half.

The central bank has lifted borrowing costs three times already this year in half-percentage-point hikes.

Additional reporting by Christine Murray; Editing by Peter Cooney, Meredith Mazzilli, David Gregorio and Kim Coghill