Mexico Inflation


Banxico maintains monetary policy stance, continues intervention in currency market

The Central Bank of Mexico (Banxico) decided to hold the target of the overnight interest rate at 3.00% on 30 July, as the markets had expected. Monetary policy makers continue to face a dilemma in terms of how to deal with the interest rate hike in the United States that is on the horizon as well as the rapid depreciation of the Mexican peso.

In its statement this time, the Central Bank focused in stressing that volatility had been higher in financial markets in recent weeks due to a combination of factors. Among which are the growing expectations that the U.S. Federal Reserve (Fed) will increase interest rates soon, the deteriorating conditions in the Greek economy due to an aggravation of its debt crisis, as well as the recent meltdown in the Chinese equity markets. Looking at the economic assessment, the Central Bank remained dovish on inflation, saying that it remains below the 3.0% target and that inflation expectations are contained. In addition, the Bank said that it does not expect inflationary pressures in the short term due to the rapid fall in the value of the currency. In its assessment of the economy, Banxico recognized that, despite being firm, economic activity is far from booming.

Meanwhile, in an unusual move to act simultaneously on the interest rates front and the exchange rates front, monetary authorities—in particular the Foreign Exchange Commission (FEC)—released a non-scheduled statement in which it bolstered the mechanism to support the exchange rate. Considering that volatility in financial markets is likely to persist in the coming months and given the current level of international reserves, the FEC decided to increase the amount of U.S. dollars sold in daily auctions from USD 52 million to USD 200 million; the new rules apply from 31 July to 30 September. Moreover, the FEC stated that it would maintain a separate daily offer to auction USD 200 million, which was triggered for the third time since it was first announced in December 2014. The FEC reduced the percentage of depreciation required to trigger the auctions of USD 200 million from 1.5% to 1.0%. While Mexico still has a healthy level of international reserves, a sudden transition toward higher interest rates in the U.S. will increase volatility in financial markets further, which will take a heavy toll on emerging market currencies, and the Mexican peso will be no exception.

Moreover, in a message that Mexico’s Central Bank is prepared to act if the Fed raises interest rates, early in July Banxico announced changes to its calendar so that its decision making regarding rates will follow the Fed’s. Therefore, Banxico’s next monetary policy meeting is scheduled for 21 September (the meeting had been scheduled for 3 September), which is just a few days after the FOMC meeting on 16–17 September.

Although the majority of analysts surveyed by LatinFocus Consensus Forecast believe that Mexico’s Central Bank will increase interest rates in tandem with the U.S. Federal Reserve, a few analysts still consider that the Central Bank will leave interest rates unchanged this year. On average, the panel considers that the target of the overnight interest rate will end this year at 3.31%. For 2016, the group of panelists surveyed expect the target of the overnight interest rate to end at 4.25%.

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Mexico Inflation Chart

Mexico Monetary Policy July 2015 1

Note: Banxico target rate (Tasa objetivo de fondeo bancario) in %.
Source: Mexico Central Bank (Banxico).

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