Mexico's central bank springs surprise interest rate cut despite high inflation

Mexico's central bank (Banxico) surprised the market by cutting the benchmark interest rate by 25 basis points to 10.75% despite inflation remaining well above the 3% target and projections even having risen for the coming quarters. 

The rate had been at 11% since March, but Banxico's governing board approved the reduction by three votes to two, with bank governor Victoria Rodríguez Ceja also voting in favor. 

However, analysts were quick to criticize the decision, pointing out that both the credibility of the monetary authority and price stability, which has been Banxico's priority mandate since 1993, have been put at risk as a consequence.

There are indications that the central bank has prioritized economic growth on this occasion, since it has been slowing and could decelerate to less than 1.5% this year, according to various analysts. 

This rate cut is something that outgoing President Andrés Manuel López Obrador has requested on several occasions, sparking concern regarding Banxico's autonomy.

“The decision seems to be nonsensical because, on the one hand, inflation remains substantially higher than in previous [Banxico board] meetings. The arguments it gave, in which it considers that the shocks are temporary, are arguments that it could've used in the two previous meetings to cut the interest rate and it didn't do so,” James Salazar, deputy director of economic analysis at CI Banco, told BNamericas.

“Now that the inflation scenario is more complicated and complex, it does it. It's nonsensical, it lacks logic. The other absurdity is that the inflation forecast for the coming quarters was raised,” added the analyst. 

General inflation in Mexico climbed to 5.57% in July, well above the 4.98% reported in June and its highest level since May 2023 after five consecutive months of increases, statistics institute Inegi reported hours before the monetary policy announcement on Thursday.

In a statement on its decision, Banxico raised its general inflation expectation for 3Q24 to 5.2% from 4.5% and lifted its forecast for 4Q24 to 4.4% from 4.0%. For 1Q25, it also increased its projection to 3.7% from 3.5%.

"In the face of turbulent financial conditions and deteriorating expectations for the peso, today's [Thursday] monetary decision is imprudent and shows a lack of commitment to the priority mandate of price stability, putting the credibility of monetary policy at risk," Alfredo Coutiño, director of Moody's Analytics, posted on his X account.

“Banxico’s sole mandate does not include economic growth or public finances as a priority,” added Coutiño, who considered the decision to be “an unnecessary risk.”

The cut comes just days after international markets suffered heavy losses due to increased expectations of a recession in the US and the decision of the Japanese central bank to raise its interest rate to 0.25%, generating volatility in the main stock markets and leading the peso to depreciate to over 20 to the dollar.

"The cut can be justified by the fact that prices may fall if economic activity is declining, since inflation will eventually moderate and what matters most is core inflation, and that continues to fall. But the truth is that inflation remains far from the 3% target," said Salazar.

"In this sense, it seems that other things are being prioritized and it may cast some doubt on [Banxico's] credibility that they're really committed to the fight against inflation, which should be its only mandate," he added.

On the positive side, the Mexican peso was not greatly affected by the monetary policy announcement, as some analysts had predicted.

“Banxico was lucky today. The markets in the US are having their best day in more than a year and that is allowing the peso to recover. This effect prevailed over the depreciation that we would have expected with a rate cut,” Mexican economist Alexis Milo, former chief economist at HSBC México, posted on X.

"The market is more focused on external issues, it's more concerned about Japan and the health of the US, but at another time it could be a relevant issue," said Salazar.