Mexico's central bank raised its key policy rate by a larger-than-expected 50 basis points to prevent further depreciation of the peso and anchor inflation expectations.
The Bank of Mexico has now raised its rate three times by a total of 125 basis points since December last year when the U.S. Federal Reserve raised its rate for the first time since July 2006. The Bank of Mexico's benchmark target for the overnight rate now stands at 4.25 percent.
After appreciating from early February to late April this year, the exchange rate of Mexico's peso fell sharply in May and then hit a record low of 19.5 per U.S. dollars in the wake of last week's vote by the U.K. to withdraw from the European Union.
The U.K. decision, known as Brexit, slammed global financial markets as the balance of risks to growth were seen to have deteriorated with the result that major central banks in advanced economies would continue with an easy policy even longer than expected to support economic activity.
The fall in the peso heightened expectations that the central bank would raise its rate today, with most economists looking for a 25-basis-points hike.
But along with a rebound in global financial markets in recent days, the peso has also firmed and rose further today in reaction to the central bank's rate hike.
The peso was trading at 18.25 to the dollar in mid-afternoon Thursday, up from 18.3 at the start of this month and 19.5 on June 24 but still down 5.8 percent since the start of this year.
The central bank said it was closely following all inflation determinants and expectations, especially the exchange rate and its possible transfer to consumer prices, and confirmed that it would remain vigilant with respect to the monetary position between Mexico and the U.S.
Mexico's inflation rate rose to 2.6 percent in May from 2.54 percent in April but the central bank said the underlying price index was moving to be near 3 percent in the first half of June due to changes to services prices, partly due to peso depreciation.
The central bank, which targets inflation of 3.0 percent, plus/minus 1 percentage point, said it expected headline inflation to end the year "slightly" above 3 percent, though it cautioned that further depreciation of the peso remains an upside risk along with higher prices for agricultural goods.
Among the downside risks to inflation, the central bank mentioned further price reductions in telecommunication services and electricity due to structural reforms. In addition the peso could reverse some of its depreciation which would negatively affect economic activity.
"It is estimated that the balance of risks for inflation in the time horizon in which monetary policy has an effect has deteriorated compared to the previous decision," the central bank said.
Mexico's economy grew by an annual rate of 2.6 percent in the first quarter, up from 2.4 percent in the first quarter but the central bank said second quarter data showed less dynamism, with industrial production becoming sluggish in April.
"Given the changing external environment, it is considered that the balance of risks to growth compared to the previous monetary policy decision has deteriorated," the bank said.