Mexico interest rate already restricting growth, but worst to come – analysts

Mexico's benchmark interest rate, hiked to 8.5% on Thursday, is already putting a drag on the economy, with some analysts now forecasting it will be raised to 10% by year-end.

“I would argue that we are now in restrictive territory,” Capital Economics senior emerging markets economist Jason Tuvey told BNamericas, “And the effects of Banxico’s rate hikes will continue to filter through over the coming months.”

Also Thursday, Mexico statistics agency Inegi printed July annual inflation at 8.15% – the highest level in more than two decades, and as such, said Tuvey, “The government looks set to maintain its restrictive fiscal policy stance.”

Meanwhile, the economy is still showing signs of life, with Inegi's preliminary estimate for 2Q22 GDP at 1.4% year-on-year, surprising the market.

The data was “certainly better than expected. But the latest monthly activity figures have been disappointing and suggest that the economy is struggling to gather momentum," said Tuvey.

“We think that looks set to continue,” he added.

And regardless of whether the US is in recession or not, he said, growth in Mexico’s largest trading partner looks “to be weak over the coming quarters,” weighing on both goods and services exports.

RATES WILL FILTER THROUGH

“Are we already in restrictive territory for the economy at 8.5%? Yes,” said Ramsé Gutiérrez, VP and co-head of investments at Franklin Templeton Mexico, and even now “rates are beginning to be restrictive for some sectors of the economy,” he told BNamericas 

But Mexico’s economic growth has proven to be surprisingly resilient in recent years, he added, largely due to three externally driven factors.

These are, he said, record-breaking remittances, a fast restart to tourism after the start of the COVID-19 emergency and more recently, investments coming in on the nearshoring phenomenon, with corporations trying to bring an end to global supply chain disruptions.

Being external, he added, “we must be very attentive to the US economic cycle.” 

And the slowdown will soon show up in Mexico, with Tuvey citing for example, “Mexico’s tourism recovery has been strong but has probably now run its course.”

In addition, still-rising rates will take time to manifest fully in Mexico’s economy, taking four to six months to transfer to the real economy, said Gutiérrez. 

“Thus, most of the economic sectors are not yet suffering,” and some segments are still reaping the benefits of two years of exceptionally loose monetary policy, he added.

LOCKSTEP WITH FED

Like Capital Economics, Banorte’s economic analysis team sees the central bank on a path to hiking the reference interest rate 10% by December, with Mexico mirroring expected hikes in the key reference rate from the US Federal Reserve point-for-point.

In a note, Banorte sees Mexico’s central bank making a third consecutive 75bp hike on September 29, again following the Fed’s next move, then raising the rate another 75bp over the last two meetings of the year, on November 10 and December 15.

Also, “We do not see an immediate need for Banxico to ‘decouple’ from the Fed,” Banorte said, an apparent nod to a much reported UBS analysis earlier this week suggesting that the bank make a full 100bp hike to put even more space between Mexico and the Fed.

Making a deep dive on the central bank’s statement on Thursday, Banorte said the message “signals more strongly the dependency to incoming data and the relative policy stance, especially against the Fed.”

“Specifically, now they will assess the magnitude of the next upward adjustments according to ‘prevailing circumstances’, alluding to greater data dependency and the relative monetary stance with the Fed,” said Banorte.

The bank also compiled the central bank’s updated CPI forecast as a guide to how closely policy should stay on the current course, as noted in the table below.

Source: Banorte, Banco de México

“Considering the statement, our short-term inflation expectations (and the upward revision in Banxico’s estimates) and our outlook for the Fed, we reiterate our call that the reference rate will reach 10% by the end of the year,” said Banorte.

“Lastly, we continue to believe that Banxico could start cutting rates towards the end of 2023,” the bank added.