Pacific Money

Mexico Cuts Interest Rate, China Talks Currency War

With Mexico cutting rates, China’s Commerce Minister warns about the depreciation of major currencies.

Mexico cut interest rates for the first time in four years Friday, launching a debate about whether the country is entering an easing cycle and about how the economy will perform in the medium term.

The central bank’s half percent rate cut leaves interest rates at 4 percent, which marks a record low for the country.  The Bank of Mexico had been focusing on fighting a surge in inflation since 2009. Over the last two years, inflation has averaged 3.7 percent, a whole percentage point lower than in the two years prior to that. Meanwhile, at 4 percent, growth remained reasonably high last year, although this figure masked a slight slowdown at the end of the year, when the country’s retail sales and industrial production slowed for the first time in the post-crisis period.

This move will only heighten the concern of some economists who are already warning of a currency war.  An interest rate cut normally reduces demand for a country’s currency. In this case it can be expected that the lower relative returns now available in Mexico will weaken the Peso, as investors switched into other currencies giving relatively higher returns. 

However, if this rate cut was intended as a shot in the currency war, then it backfired. The Peso actually strengthened following the move, as investors apparently focused on what the cut signaled about the strength of the economy and future prospects for as-of-now deadlocked reforms, as opposed to focusing on direct interest yields in the country. Part of this counter-intuitive reaction could also have been the result of positive data in the U.S., which is the destination for around four-fifths of Mexico’s exports.

Meanwhile, in China, Commerce Minister Chen Deming told the National People’s Congress (NPC) in Beijing that he is worried about the “deliberate depreciation of major currencies” and the consequences of this for developing nations, including China.  Ignoring the negative effect that China, the world’s number 2 economy, has had (mainly on other emerging markets) through its long running currency peg and savings rates, the speech painted China entirely as a victim. 

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Of course, nearly every nation sees itself (publically at least) as the “victim” of others’ currency policies, but China’s huge foreign exchange reserves (believed to total U.S. $3.3 trillion at the end of 2012) make Chen’s worries a little disingenuous.  The credibility of Chen’s claims is also undercut by China’s February Export-Import data, which estimated China’s monthly trade surplus at U.S. $15.25 billion.