Itaú BBA - MEXICO – Banxico minutes: cautious tone, but further easing is likely

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MEXICO – Banxico minutes: cautious tone, but further easing is likely

Abril 3, 2020

Despite the cautious tone, we expect Banxico to reduce monetary policy further in the upcoming months.

The central bank of Mexico (Banxico) published the minutes of March 20th extraordinary meeting (originally scheduled for March 26th), when four out of five members voted to cut the policy rate by 50-bp (to reach a rate of 6.50%). The minutes revealed deputy governor Javier Guzman was the member voting for a 25-bp cut, given the challenges surrounding monetary policy exerted by opposite directions of inflation pressures and rising uncertainty (reflected in the currency depreciation).   

Most board members highlighted that relative monetary policy stance may not have such an ample margin due to a higher risk premia. Some members argued that it should be taken into account the high level of sensitivity of the currency to lowering the short-term rate. Likewise, one member mentioned that a greater interest rate spread is needed given an environment of foreign exchange instability. In contrast, one board member noted that countries with high interest rates spreads suffered the sharpest currency depreciation, which is evidence against a small relative monetary policy margin.

Monetary policy is seen not as effective as fiscal policy to mitigate the fall in economic activity. Most members questioned the ability of monetary policy to smooth a negative shock in economic activity, with one board member noting the credit channel of monetary policy is low due to the low level of financial inclusion and the presence of a supply shock. On the other hand, most members noted that the current supply shock is best addressed with fiscal policy, although sustainability of fiscal accounts should be maintained.

The minutes showed divisions over the pace of monetary policy easing. Some members emphasized the importance of acting with caution. One of these members noted that under the current environment, the potential costs of excessively decreasing the policy rate are greater than those of temporarily deferring it, but acknowledged that Banxico must take advantage of the space that becomes available to further ease monetary policy. In contrast, one board member said that while excessive easing could send a wrong signal for the formation of inflation expectations, the current emergency situation suggests putting less emphasis in meeting the point inflation target in the short run, calling for a more significant policy reduction. 

Despite the cautious tone, we expect Banxico to continue easing its monetary policy stance. The widening of output gap and loose monetary policy abroad supports the central bank continue cutting the policy rate. However, the depreciation for the currency may turn the majority of the board reluctant in delivering a more front-loaded easing cycle. We currently expect the policy rate to end this year at 5.5% but risks are tilted towards a lower interest rate.
 

João Pedro Bumachar 
Julio Ruiz



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