Split rate decision adds color to Mexico monetary policymaking

Mexico’s central bank maintained the benchmark interest rate at a 10-year high of 8.25% at its monetary policy meeting Thursday, citing continued high uncertainty over risks to inflation.

The vote, however, was not unanimous, with one board member voting for a 25-basis-point rate cut, most likely coming from Gerardo Esquivel, one of two members appointed by President Andrés Manuel López Obrador.

In recent remarks, Esquivel has been critical of the hawkish language emerging in recent announcements, with the last four meetings of the central bank’s monetary policy board holding firmly against any interest rate reduction.

While recognizing that the overall message from the monetary authority remained cautious, the board member who voted for a cut "has forced easing firmly onto [central bank] Banxico's agenda,” said Edward Glossop, an economist for Latin America at Capital Economics.

“The markets have rapidly come round to our view in recent weeks, but we continue to expect 75bp of rate cuts (to 7.50%) by year-end,” he added. “As things stand, investors are pricing in 50bp of cuts over the same period.”

"The context of the meeting," wrote Glossop, "is one in which investors’ expectations for monetary easing over the next 12-18 months have risen dramatically. That comes on the back of weaker-than-expected growth so far this year, but also expectations for larger US rate cuts."

Focus turns to growth

The board's rate announcement added weight to the discussion of the Mexican economy's disappointing performance, mentioning the recent “cascade” of GDP growth forecast reductions, including their own. The central bank reduced its 2019 growth estimate to 0.8%-1.8% from 1.1%-2.1% in the Q1 inflation report that was released in late May.

The announcement even went so far as to tack on a nod to deteriorating growth prospects in the all-important summary paragraph of the message, noting that it would also be tracking “the behavior of slack conditions” – a clear nod to GDP growth – in addition to “cost-related pressures” in its coming decisions.

Still, inflation concerns reigned in Thursday’s message, with the central bank once again mentioning concerns of pass-through effects from FX volatility into local price formation.

The bank did, however, acknowledge how the peso has recovered in recent weeks from the marked weakening in early June coming with the introduction of a US threat of blanket tariffs and subsequent downgrades from rating agency Fitch on the sovereign and state-run oil giant Pemex.

“Nevertheless,” wrote the bank, “Risks to the global economy persist: a further escalation of trade tensions between the United States and its main trade partners; the weakness of some of the major economies extending longer than foreseen; new episodes of volatility arising in international financial markets; and, the intensification of certain political and geopolitical risks.”

In this context, the bank urged the government to maintain fiscal responsibility and foster investor confidence and certainty moving forward, adding that the administration must also address the deterioration of both the sovereign’s and Pemex’s credit ratings.

With regards to risks to inflation, it added, “some have diminished and others have gained relevance” with “the possibility that the peso exchange rate comes under pressure stemming from external or domestic factors” standing out.

The bank pointed out that headline inflation had once again fallen to the upper end of its 2-4% target range in mid-June, after creeping up to 4.41% in April, “due to the significant decline of the non-core component, which went from 6.08% to 4.34%.”

That said, the bank noted how market indicators continue to show that “medium-and long-term breakeven inflation expectations remain at high levels,” and as such, the board would continue to exercise a “prudent monetary policy stance.”