Itaú BBA - MEXICO – Monetary policy minutes: further gradual rate cuts are likely

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MEXICO – Monetary policy minutes: further gradual rate cuts are likely

Janeiro 2, 2020

Divisions over the balance of risks for inflation remain

The central bank of Mexico (Banxico) published the minutes of December’s meeting, when four out of five members voted to cut the policy rate by 25-bp (to reach a rate of 7.25%). The minutes revealed deputy governor Gerardo Esquivel was the member voting for a 50-bp cut. Esquivel argued that a 25-bp rate cut was insufficient to acknowledge the progress attained in reducing inflation and mitigating inflationary risks, while also mentioning that this was probably the last opportunity to make a rate adjustment of a greater magnitude.  

Most board members are concerned over the effect of the minimum wage on inflation. For 2020, the majority of board members considered headline and core inflation will reflect both the widening of slack conditions and cost pressures that could stem from the minimum wage hike. Some members noted that the recent announcement of the minimum wage for 2020 will turn inflation convergence to the 3% target in 2020 (as foreseen in the latest quarterly inflation report) challenging. 

Divisions over the balance of risks for inflation remain. One board member clarified that the balance of risks now applies to a higher forecasted path for inflation. One board member considered the balance of risks for inflation is slightly tilted to the upside. On the other hand, one board member described the balance of risks for inflation as uncertain in the long term and symmetric in the short term, while one board member considered inflation risks have diminished during the year, indicating a more benign external environment and lower internal uncertainty. 

Most board members are advocating for gradual rate moves. These members argued that monetary policy must respond to the evolution of inflation relative to its foreseen path, adding that external and internal risks prevail and expressing concern about medium and long-term inflation expectations remaining above the 3% target. One board member left clear that the monetary policy rate should remain above neutral levels. He/She mentioned the possibility of an inflation above the central bank’s foreseen path would hurt its credibility, reaffirming the need for a gradual easing cycle within the restrictive range. This same member advocated for the inclusion in the statement of the fact that the monetary policy is in a rate-cutting cycle. 

Two board members seem to have a more hawkish stance. One of these members noted that a monetary easing of more than 25-bp wouldn’t be convenient, as it would probably validate the inflationary impact of the minimum wage adjustment, which would justify having long-term inflation expectations above target and wouldn’t have a substantial positive effect in the economy. Likewise, another member mentioned that the policy rate should be determined every period  taking into account the possible rebound of inflation due to core inflation persistence, the reversal of non-core CPI, the probable rebound of the economy in 2020 and the evolution of internal and external factors.

We expect Banxico’s monetary policy rate to reach a level of 6.00% end of 2020 (from its current level 7.25%). The still-high level of core inflation and inflationary risks associated to domestic policies (for instance, minimum wage increases) will likely stand in the way of a more front-loaded easing cycle. On the other hand, activity weakness, the well-behaved currency and the low level of headline inflation support gradual rate reductions towards a less restrictive policy stance. 

João Pedro Bumachar
Julio Ruiz

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