Weak Mexican peso stokes price pressure, shakes up central bank

Mexican companies warn they will have to raise prices if a steep slide in the peso currency persists, adding pressure on the central bank to hike interest rates despite a weak economy.

With economic growth running at only slightly above 2 percent, business leaders have mainly held back from passing the increased costs of imported goods and materials on to consumers, but some now say they cannot continue to bear the full burden.

"If the exchange rate stays at 16 per dollar or weaker, in the next two months we'll surely need to make some adjustment, because it won't be possible to keep absorbing these types of shocks," said Juan Casados, general director of Concamin, a confederation representing Mexican industry associations.

Price hikes by manufacturers could push service providers to follow suit, unleash demand for higher wages and undo Mexico's success in bringing down inflation.

The peso has fallen by about 20 percent against the dollar since last July and is the 10th worst-performing among the world's 36 most-traded currencies this year, Reuters data shows.

Eight record peso lows in July alone reawakened memories of past devaluations that caused havoc to Mexico's economy.

The U.S. Federal Reserve may start raising rates in September and Mexico is likely to quickly follow. That may help the peso stabilize, but it may not happen soon enough.

Marcello Hinojosa, who runs a waste-recycling firm in the northern border city of Tijuana and imports about 30 percent of his inputs, says his business had been shouldering higher import costs since September.

"Now it's so much that we're more than 20 percent higher and we can't absorb the total cost of this increase," said Hinojosa, the head of a local chapter of lobby group Canacintra, which represents industries ranging from food and drink, chemicals, construction, home furnishings and other manufacturers.

"We're going to have to raise prices," he added.

Business leaders should be careful about stoking inflationary expectations, said Banamex economist Sergio Luna.

"There is a psychological element in all of this," he said, noting financial authorities would be following warnings from business leaders about price pressures "very closely."

Tepid demand should prevent any sharp moves though, say economists. Growth has fallen short of forecasts for three years running.

INTERVENTION

Importers have already passed on some cost increases. Annual inflation for non-food goods rose to 2.65 percent in early July, up 86 basis points from the same month last year.

Over that period, annual inflation cooled to a record low of 2.76 percent as services cost pressures eased, helped by lower phone bills following a telecommunications reform and a decline in some commodity prices that outpaced the peso's fall.

Those dampening effects will fade by next year, and if the peso remains weak, rising costs could push inflation back above the central bank's 3 percent target.

Still, any price increases should only reflect a fraction of the depreciation because companies can avoid passing on local costs set in pesos, including distribution, said Armando Garza Sada, chairman of conglomerate Alfa.

"Normally, if it ends up being lasting, a devaluation of 10 percent, prices could rise between 2 and 3 percent," he said. "I'm sure the Banco de Mexico won't let the devaluation hit inflation."

Policymakers intervened late last week, when Mexico's currency commission nearly quadrupled the sum auctioned to support the peso to $200 million a day and lowered the threshold that can trigger the sale of $200 million more.

Central bank chief Agustin Carstens then said on Friday that policymakers could raise rates at any time, even before the Fed if the peso needs the support.

The interventions lifted the peso off Thursday's record low, but it is still above 16 per dollar, in terrain that was previously uncharted before late July.

Despite the support, traders could try to drive down the peso to test the central bank's willingness to hike rates.

"The governor is making all the right noises. As he should, given the volatility," said Andrew Stanners, a fund manager at Aberdeen Asset Management in London. "But clearly the macro backdrop and current low pass through means the market could test that conviction."