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MEXICO – Monetary policy decision: a neutral stance

August 10, 2017

Board reaffirmed that it’s baseline scenario is not to hike anymore

After hiking rates for seven consecutive meetings (and 400-bps since December 2015), the Central Bank of Mexico stuck to the guidance provided in the last meeting – which signaled the end of the tightening cycle – by deciding to leave the reference rate unchanged at 7%. The Board reaffirmed that the current level of the reference rate is consistent with the convergence of inflation to the 3% percent target. Nevertheless, just like in June, it qualified this assertion by arguing that, given various risks, the Board “will be vigilant to ensure a prudent monetary policy”, suggesting there is no room for rate cuts and rate hikes remain a possibility should inflation deviate significantly from the path forecasted by the monetary authority.

However, compared to the previous statement, we note a somewhat more benign assessment of the inflation readings (although the board still sees a neutral balance of risks for inflation). Notably, the board downplayed the further increase of annual inflation (to 6.44% in July, from 6.31% in June) by stating that the recent pressure has been attributable to one-off increases in agricultural prices. In fact, the statement mentions that, excluding the spike of tomato prices, annual inflation would have fallen to 6.17% in July. Moreover, the statement mentions that the trends of inflation for energy and non-food core goods are already changing (after being shocked by the Mexican peso depreciation and the liberalization of gasoline prices in early 2017).

Turning to the balance of risks for GDP growth, the board modified its assessment to neutral (from negative in June’s statement). To justify such change, the statement mentions a lower probability for a deterioration in bilateral relations with the U.S. (probably because of more clarity on the course of NAFTA renegotiation) and the decision of some rating agencies (S&P and Fitch) to revise Mexico’s credit rating outlook to stable from negative (which implies that a sovereign downgrade is now unlikely).      

Our base-case scenario is that Banxico will take a cautious approach in light of the Fed rate hikes and the uncertainty surrounding the presidential election next year, maintaining the reference rate at 7% until 2H18. Rate cuts to support the economy are unlikely to be implemented anytime soon. Importantly, the statement continues mentioning the relative monetary policy stance between Mexico and the U.S. as an important variable to monitor, so rate hikes in the U.S. (which we expect to continue throughout 2018) reduce the odds of rate cuts in Mexico. Also, the heating-up of political campaigning by the end of the year, with the presidential elections coming closer (July 2018), will pose risks on the exchange rate (and inflation), and many board members already hinted that this limits the room for monetary policy action. Finally, we highlight that the authorities do not see the current level of policy rate as excessively tight (or tight at all) and the economy will likely perform well in 2018, supported by robust U.S. growth coupled with lower protectionism risk, so there would be no urgency for reducing interest rates.    


 

Alexander Müller


 

 



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