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Mexico's central bank on Wednesday unexpectedly raised its benchmark interest rate by 50 basis points to 3.75 percent, sparking a rally in the long-battered peso currency, while the government vowed to cut spending.
The central bank also intervened directly in the foreign exchange market to sell dollars as part of a major policy shift to support the peso, which plunged to fresh lows in recent weeks.
"This is not the beginning of a cycle of interest rate hikes," said Agustín Carstens, governor of the Banco de Mexico, the country's central bank. "It was a way of showing our protest, our clear rejection of those levels" of the peso against the dollar, he said.
The shift in foreign exchange intervention policy marks an unexpected break from Banco de Mexico's general preference for rules-based intervention and is the first time since 2009 that it has opted for direct dollar sales.
Finance Minister Luis Videgaray said the government would make spending cuts to the 2016 budget to the tune of 132 billion pesos (US$7.23 billion), or about 0.7 percent of gross domestic product. State oil company Pemex would account for 100 billion pesos of those expenditure cuts, he said.
"Man, catching everyone by surprise. These guys are going the classical defense route. One would've figured that they wouldn't hike after the cuts from Hacienda/PEMEX," said Edwin Gutiérrez, head of emerging market sovereign debt at Aberdeen Asset Management in London.
The peso, which has been hit by sinking oil prices, surged on Wednesday, approaching its strongest level since Jan. 15, after marking a new all-time low last week at 19.4480 per U.S.dollar. The currency gained as much as 4.86 percent on Wednesday to 17.962 per dollar, at one point posting its biggest one-day gain since September 2011. It last traded at a rise of 3.15 percent on the day to 18.2850 per greenback.
Not all analysts welcomed the move. "They are putting all the meat on the grill and they could end up with no tools when things get even worse," said Marco Oviedo an Economist at Barclays in Mexico City. Mexico's economy has slowed as uneven U.S. demand for its exports and tumbling oil prices have hit industrial production, but domestic spending has held up.
