Mexico seen sticking to cautious rate cuts

(Bloomberg) — Mexico’s central bank is projected to cut its key interest rate by a quarter point for a fifth straight decision, as stagnant growth prompts officials to lower the highest inflation-adjusted borrowing costs among the world’s biggest economies.

Banco de Mexico will reduce rates to 7% on Thursday, according to the median forecast in a Bloomberg survey. Prospects for faster, half-point cuts dimmed after one board member advocating a more aggressive reduction changed his mind in December and inflation accelerated.

Investors have slashed Mexico’s 2020 growth estimates after the economy contracted last year, according to preliminary data. Even after reducing the key rate by one percentage point last year, Mexico has the highest real rate among Group of 20 nations, meaning there’s plenty of space to cut.

But core inflation, which excludes more volatile food and energy prices and has been a recent focus for the central bank, quickened in January and remains above policy makers’ 3% goal. That means policy makers will likely continue a measured approach to easing.

“In the face of a rebound in inflation, the central bank has to appear cautious and prudent — that they’re cutting but not going out of their way to ease aggressively,” said Alonso Cervera, chief Latin America economist at Credit Suisse Group AG in Mexico City.

Close up of Mexican Peso banknotes and coins.

Policy makers have been lowering rates since August as declining oil output and uncertainty over President Andres Manuel Lopez Obrador’s policies stalled the economy. Central bank Governor Alejandro Diaz de Leon said in a year-end interview that the board could act on monetary policy again this month if inflation and internal and external risks remained low.

Peso Strength

Mexico’s peso has provided one point of stability. Often used by investors to bet on emerging markets due to its abundant liquidity, the currency last week touched the strongest level in nearly a year and a half. The main attraction has been the better yield on peso-denominated debt due to Mexico’s higher borrowing costs.

The peso has been the best performing major currency against the dollar in 2020 despite global concern about the spread of coronavirus.

Given Mexico’s relatively high real rates coupled with economic weakness, analysts expect the central bank to slash borrowing costs by another half point in the rest of 2020 following Thursday’s decision, ending the year at 6.5%. JPMorgan Chase & Co. expects additional quarter-point cuts at the next policy meetings in March and May.

Inflation Risks

Despite the economic slack, some consumer price risks persist. Aside from its concern over core inflation, the central bank expects the headline number, which accelerated to 3.24% in January, to average 3.5% in the first quarter before slowing to 3% by year-end.

What Our Economist Says

“We believe the central bank is still cautious and only will want to go by 25 points instead of 50 points. Core inflation remains quite resilient despite increasing economic slack.”

— Felipe Hernandez, Latin America economist for Bloomberg Economics

— Full research, click here.

In minutes of its December meeting, some central bank board members said that a 20% boost to Mexico’s minimum wage at the start of the year will make it hard for policy makers to reach their inflation target going forward. They also said that it could hurt the labor market just as the economy struggles.

After both of Lopez Obrador’s central bank appointees voted for half-point rate cuts in September and October, only Gerardo Esquivel supported a more drastic cut in December, creating a 4-1 vote. Thursday’s decision may be unanimous, with all five members supporting a quarter-point cut, said Gabriel Casillas, chief economist at Grupo Financiero Banorte SAB, the nation’s largely publicly-traded bank.

“One important change in the board’s bias was Jonathan Heath moving to 25 basis-point cuts,” Casillas said. “Given recent statements and tweets by Gerardo Esquivel, we may see the first unanimous decision” since before the rate reductions started in August.

Source: Bloomberg

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