Impact of Expected Central Bank Policy Shift on Mexico’s Peso
Anticipated Weakening of Mexico’s Peso
The rally in Mexico’s peso is likely to lose momentum this year due to an anticipated shift in central bank policy. The policy change is expected to result in a less restrictive approach, potentially reducing the currency’s attractive rate spread, as revealed by a Reuters poll.
Previous Peso Performance and Future Outlook
In 2023, the peso experienced its strongest performance against the dollar in over three decades, mainly attributed to the central bank’s strategy of leaving its key rate at a multi-year high of 11.25%. This move was aimed at curbing inflation and driving inflows into the country. However, the peso is now projected to trade at 18 per dollar by year-end, indicating a potential 5.4% decline from its current value of around 17. This forecast is based on the median estimate of 25 currency strategists polled in early January.
Factors Contributing to the Peso’s Expected Decline
The projected drop in the peso’s value surpasses the consensus inflation forecast of 4.0%. This suggests that, apart from the traditional adjustment to rising consumer prices, the currency will also face pressure from narrower rate differentials due to the expected policy shift. As per Montserrat Aldave, principal economist at Finamex, the rate spreads between Mexico and the United States are anticipated to decrease by 100-150 basis points as central banks begin to ease in 2024.
Rate Differentials and Political Events
Currently, Banxico’s rate offers a significant margin over the U.S. Federal Reserve’s rate, attracting investors to engage in profitable “carry trade” bets. However, Mexico’s central bank is considering a rate cut in the first quarter of 2024, as stated by the bank’s governor. Additionally, the upcoming presidential election in Mexico could also impact the peso, although historical data suggests that volatility tends to increase only one month before the election and then subsides afterward.
Comparison with Other Currencies
Despite its strong performance last year, the peso is expected to face challenges in 2024, with the Brazilian real also experiencing fluctuations. While the peso gained 15% in 2023, surpassing the Brazilian real’s 9% advance, the real is projected to end 2024 slightly weaker at 4.95 per dollar, remaining close to the 5.0 mark for a third consecutive year.
Reporting and polling by Gabriel Burin in Buenos Aires; Additional polling by Indradip Ghosh, Mumal Rathore and Susobhan Sarkar in Bengaluru; Editing by Andrew Cawthorne
