Bucking expectations, Banxico lowers the interest rate, despite some inflation concerns

Mexico’s central bank (Banxico) lowered its benchmark interest rate 25 basis points to 6.25%, surprising analysts, who as recently as this week expected the rate to remain unchanged. 

In a split vote, the three bank governors supporting the reduction argued that there are no perceived demand pressures in the economy and that the degree of monetary restriction implemented is still in effect.

In a statement, Banxico adjudged that the disinflationary process has continued, indicating that, “given the prevailing slack conditions, the pass-through of exchange rate movements to prices would be limited.”

In what is viewed as guidance for future actions, the statement added that “going forward, the Governing Board believes that maintaining the rate for an extended period at the level achieved will support the convergence of inflation to its target and will be appropriate to meet external macroeconomic challenges.”

At the same time that Banxico reduced the interest rate, it raised its headline inflation forecast for the fourth quarter from 3.5% to 3.7%, acknowledging that risks remain tilted to the upside.

“This is mainly due to higher-than-anticipated levels for non-core inflation,” the statement said.

The bank also incorporated an upward adjustment to its estimate of core inflation for the last quarter, from 3.6% predicted in September to the 3.7% they now anticipate.

Although the economy continued to expand in the third-quarter, Banxico believes that “slack conditions are still expected throughout the forecast horizon, and downside risks to economic activity persist.”

Still, Banxico believes that its estimate that inflation will reach its target — 3% with a tolerance range of plus or minus 1 percentage point (2% to 4%) — by the fourth quarter of next year.

Banxico’s economic research identified four upside risks to its inflation forecasts: the persistence of core inflation; further depreciation of the peso; disruptions from trade policies or an inflationary impact from geopolitical conflicts; and, climate-related effects and unspecified cost pressures.

Looking ahead, the Governing Board said that maintaining the rate at its current level for an extended period “will support the convergence of inflation to its target and will be appropriate to address external macroeconomic challenges.”

Thursday’s surprise decision — 30 of the 36 institutions consulted by Citi expected the rate to remain unchanged — impacted the currency exchange market immediately.

The reduction pushed the dollar as high as 18.96 pesos during the day, although it later moderated its advance and closed at 18.7499. The peso lost 18.3 centavos, or 0.99%, compared to Wednesday’s close.