Mexico Joins the Global Battle Against Inflation with Surprise Rate Cut

By Jason Simpkins
Associate Editor

Mexico's central bank unexpectedly raised its benchmark interest rate by a quarter percentage point to 7.75% Friday, warning that the rate of inflation may exceed its previous forecast.

"The recent inflation dynamic is worrying," Banco de Mexico's five-member board said in a statement. "The balance of risks for inflation has worsened."

Consumer prices in Mexico jumped nearly 5% in May from a year earlier, the biggest jump since 2004, according to Bloomberg News. The government has issued a price freeze on tortillas, cooking oils, beans and roughly 150 other items this year to ensure its population is adequately fed.

The decision surprised many analysts as it flouted the country's president, Felipe Calderon, who has hinted that borrowing costs are already too high. Still, inflation demanded Mexico's attention as soaring food and energy costs have resulted in what has fast become a worldwide inflation epidemic.

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Soaring fuel prices pushed India's inflation rate to a 13-year high in early June, adding to speculation the central bank may accelerate its own monetary tightenting initiative, Financial Times reported. Inflation reached 11.05% in the 12 months ended June 7, up from 8.75% the previous week, and well above the 9.82% median forecast in a Reuters poll of analysts, the paper reported on its Web site.

Earlier this month, the Reserve Bank of India announced a surprise rate increase of its own, pushing its key lending rate up 25 basis points to a full 8%. The bank also raised its cash reserve ratio – the amount of cash banks must keep on hand – by 25 basis points to 8.25% as recently as April 29.

In China, consumer prices rose 7.7% in May after inflation reached a 12-year high of 8.7% in February. China's producer price index rose 8.2% in May, the highest in more than three years.

The problem isn't any better in mature markets either. Eurozone inflation hit a 16-year high in May, as costs pushed inflation up 0.6% to an annualized rate of 3.7%. High commodity costs fueled the increase, as food costs jumped 6.4% in May up from 6% in April. Energy prices soared 13.7% year-over-year on the back of record high oil, up from a 10.8% increase the month prior.

In the United States, the producer price index (PPI) jumped 1.4% in May, the largest increase since November. Over the last 12 months, producer prices have increased 7.2% compared to the 6.5% increase in April.

"Just about everywhere prices are rising and they are doing so at a strong pace," said Joel Naroff, president and chief economist at Naroff Economic Advisors. "While the pathway from intermediate and crude goods price increases to consumer prices is quite unclear, it is never good news to see the extensive nature of price increases that were contained in this report."

After nine months of cutting interest rates and lending freely to financial firms hoping to ease the credit crunch pain, U.S. Federal Reserve Chairman Ben S. Bernanke is signaling a new willingness to reverse course and battle inflation.

"The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so," Bernanke said earlier this week. "The Federal Open Market Committee (FOMC) will strongly resist an erosion of longer-term inflation expectations."

The FOMC is scheduled to meet June 24 and 25. It is widely expected that it will vote to hold rates steady.

News and Related Story Notes:

• Bloomberg:
  Mexico Central Bank Unexpectedly Raises Lending Rate

• Financial Times:
  Fuel prices push Indian inflation past 11%

• Money Morning:
  ECB Stands Firm Against Inflation

• Money Morning:
  India Fuels Inflation by Bailing Out Refineries

• Money Morning:
  ECB Rate Hike More Likely After European Inflation Hits New High