In a dispute over migration, Trump said he would introduce punitive tariffs on June 10 if Mexico does not halt the flow of illegal immigration from Central America, battering the currency of Latin America's second-largest economy.
The Mexican peso lost as much as 3.62% on Friday in early trading, touching its worst level so far this year before erasing some losses. It was the deepest drop since Mexican President Andres Manuel Lopez Obrador abruptly cancelled a $13 billion (10 billion pounds) airport project in October.
Mexico's Central Bank Governor Alejandro Diaz de Leon tried to calm a nervous market with assurances the bank was monitoring the situation closely, and had several options to intervene.
"This type of news that casts doubt over the status of external accounts, the capacity and terms over which can be sell and buy currencies, obviously, affects the exchange rate," Diaz de Leon told local radio programme Formula Financiera late on Thursday.
Diaz de Leon said while the Mexican peso could deepen its losses against the dollar, it was a widely held and traded currency that could withstand some pressure.
"We will be very attentive to these risk factors that we had originally viewed as somewhat further away but that now appear to be intensifying," Diaz de Leon said.
"It is clear that we not only have a solid macroeconomic strategy with a monetary policy, public finances, solvency and resilience in financial institutions but also liquidity instruments in foreign currency in case it were necessary."
Until Thursday, the peso had held up well against repeated economic growth downgrades by private economists and the central bank itself, and concerns among Mexican companies about the direction of policy under the young government of Lopez Obrador.
In central bank minutes from a May 16 monetary policy meeting, released on Wednesday, the board noted the peso's strength against the dollar in recent months was partly down to overseas funds seeking Mexico's higher yields.
"The majority noted that Mexico's relatively high interest rates in comparison to other economies has contributed to the good performance of the peso," the report said. The bank raised its interest rate to 8.25% on Dec. 20.
If implemented, Diaz de Leon said the tariffs could eventually lead to higher inflation as well as hurt Mexico's manufacturing and exporting sectors.
The bank had cut its growth forecast for 2019 to 0.8%-1.8%, from 1.1%-2.1% previously, the fourth time it has lowered its outlook. Lopez Obrador has said the economy would grow "at least" 2% in 2019 and 3% in 2020.
(Reporting by Noe Torres, Stefanie Eschenbacher and Miguel Angel Gutiérrez; Editing by Tom Brown)
By Noe Torres
