Fed's hawkish tilt pressures Mexico's Banxico, but no hike seen

© Reuters. The logo of Mexico's Central Bank (Banco de Mexico) is seen at its building in downtown Mexico City, Mexico February 28, 2019. Picture taken February 28, 2019. REUTERS/Daniel Becerril/Files

By Anthony Esposito and Abraham Gonzalez

MEXICO CITY (Reuters) - The Bank of Mexico is widely expected to keep its benchmark interest rate on hold at 4.0% on Thursday, in the face of pressure to hike after Federal Reserve officials last week brought forward the first projected U.S. rate increases.

The Fed on June 16 began closing the door to its pandemic-driven monetary policy with most officials at the U.S. central bank moving their first projected rate increases to 2023 from 2024, what some in the market dubbed a "hawkish surprise". Some even saw rate rises starting next year.

That prompted Mexico's peso to depreciate some 5% versus the U.S. dollar in the following days, which experts said will be factored in by board members of Banxico, as the bank is known, at the Thursday monetary policy meeting.

"They will not change the interest rate (on Thursday), but before the end of the year the Bank of Mexico will have to partially normalize the rate, that is, raise it moderately," said Joel Virgen, an independent analyst who was chief economist for Mexico at Citibanamex and BNP Paribas (OTC:BNPQY).

"Inflation pressures are still there, short-term expectations continue to be contaminated, and medium-term expectations are still above the central bank's target," Virgen said.

Most market observers expect Banxico to hike rates in the coming months to stem inflationary pressures, although there is little consensus around when exactly that could occur.

Banxico's latest poll of analysts forecast the key rate would end 2021 at its current level and be hiked by 50 basis points to 4.50% by the end of 2022.

Some think that changes to Banxico's board since 2018, giving it a dovish tilt, make it less inclined to move quickly.

"We think that the main and under-appreciated risk to inflation will play out over the medium term, as Banxico could move too slowly to contain stubbornly high inflation," said Nikhil Sanghani, emerging markets economist at Capital Economics.

"There seems to be a high bar for raising rates as Banxico's reaction function is becoming more dovish."

Banxico at its last monetary policy meeting on May 13 kept the key interest rate steady in a unanimous decision by its five-member board, reflecting growing concerns about the path of inflation.

It marked Banxico's second decision in a row to keep the rate steady.

Minutes of the May meeting showed that most board members see the balance of risks for inflation as biased to the upside, even as inflationary pressures are expected to be transitory.

A Reuters poll showed on Monday that annual inflation likely slowed in the first half of June to 5.84% after hitting 5.89% in May. Both figures exceed the central bank's target range of 3%, plus or minus one percentage point.

Since 2019, the bank had cut interest rates by 425 basis points, as the economy contracted even before the COVID-19 pandemic hit.