ANALYSIS – Mexico’s central bank may tap brakes on peso surge

By Reuters Staff
April 6, 2010

By Michael O’Boyle and Patrick Rucker

MEXICO CITY, April 6 (Reuters) – Mexico’s central bank could try to tap the brakes on a dogged appreciation in the peso before currency gains start to threaten the competitiveness of local exports.

The peso strengthened 6.0 percent in the first quarter to trade at its strongest in almost 1-1/2 years, thanks to a rebound in demand for Mexican exports from the country’s top trading partner the United States.

Mexico’s central bank has been buying U.S. dollars since March to build a war chest of reserves ahead of any possible volatility in global markets once the United States begins to raise interest rates. The program has also poured pesos into the market.

Countries like Brazil and Colombia have recently used similar tactics to help dilute the value of their currencies and some analysts are betting that Mexican policymakers could accelerate their dollar buying to slow the peso’s advance.

“The central bank will increase its mechanism to accumulate reserves, and this will undermine the peso’s momentum,” said Gabriel Casillas, an economist at JPMorgan in Mexico City.

So far the Mexican government has given mixed messages.

Last month, Finance Minister Ernesto Cordero told Reuters Mexico wanted to accumulate as big a reserves cushion as possible.

But Central Bank Governor Agustin Carstens followed up by saying there were no plans to ramp up its dollar purchases.

The peso was crushed in late 2008, losing a quarter of its value, as the global financial crisis pushed investors to dump emerging market securities, and remained weak last year due to the collapse in U.S. demand.

This year, a nascent recovery has made the peso an emerging market darling again, with U.S. interest rates seen stuck close to zero for some time. Foreign holdings of Mexican government bonds have surged and analysts predict further strong gains for the peso, which firmed as much as 0.17 percent to 12.2130 per dollar, helped by fresh signs that U.S. rates are on hold.

ANY OPTIONS?

A much stronger peso would raise the costs of Mexican goods and so curb an advantage over other exporters to the United States.

“A very strong peso is beginning to make the government uncomfortable because it cuts into the competitiveness of exports and slows down growth a bit,” said Alonso Madero, who helps manage $5.2 billion at Mexican brokerage Actinver.

Mexico’s central bank has been committed to a free-floating currency since an economic crisis in the mid-1990s. Analysts say policymakers would not try to defend any particular level — or even acknowledge that they are worried about the peso’s appreciation.

However, the bank’s current program of buying dollars through monthly sales of put options has the parallel effect of increasing peso supply and if increased might keep a cap on an accelerating peso.

In late February, the central bank began selling $600 million per month in dollar options to banks and the market has been burning through those contracts at an increasing rate.

It took three weeks for the central bank to accumulate $600 million from local banks in March. On Monday, the first trading day of April, banks unloaded $501 million — almost the entire months’s goal — into central bank coffers.

With only $99 million in options left to be exercised in April, some analysts think the central bank could soon offer to hold a second auction of dollar options whenever banks use up the existing allotment before mid-month.

The central bank used a similar strategy of transparent dollar purchases when it boosted reserves in the late 1990s.

In the short term, adding to dollar option sales could dent the peso’s advance, but longer term the effect of building up healthy dollar reserves will likely help the peso strengthen even further, even if few see it returning to pre-crisis levels.

“The lasting perception is that Mexico’s international reserves will keep growing, and that is a sign of strength,” said Luis Flores, an analyst at brokerage IXE who expects the peso to gain almost 3 percent to 11.90 to the dollar in the next couple of months. ((michael.oboyle@thomsonreuters.com; Tel: +52 55 5282 7160; Reuters Messaging: michael.oboyle.reuters.com@reuters.net))

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