Mexico: Central Bank surprises markets with rate cut
June 6, 2014
At its 6 June monetary policy meeting, the Central Bank (Banxico) decided to cut the target for the overnight interest rate by 50 basis points to 3.00%, which was a decision that took market analysts by surprise. The cut, which is the first since a 25 basis-point cut was made in October, brought the main monetary policy rate to the lowest level on record.
The Central Bank stated that the sluggish growth observed in the last quarter of 2013 persisted in the first quarter of this year, mainly due to the fact that government spending, private consumption and fixed investment were still weak. The Bank also underlined that the pick-up in exports has not been strong enough to compensate for lackluster growth in domestic demand. Moreover, monetary officials pointed out that, although April’s data suggest that the economy is gradually improving, overall economic growth in the full year 2014 will be slower than expected. In fact, the Central Bank reduced its growth projections for this year and it now expects the economy to expand between 2.3% and 3.3% versus the 3.0% to 4.0% that was previously projected.
Banxico added that, within a context of weak economic growth, inflationary pressures have faded. Inflation has gradually returned to the Bank’s target of 3.0% with a tolerance margin of 1.0% and monetary officials recognized that core consumer prices—which exclude volatile fresh food and oil prices—are also moderating. Consequently, inflation expectations for the medium- and long-term remain stable and, for this year, inflation is expected to stay within Bank’s target.
Banxico justified its decision to cut the rate by citing the backdrop of tepid domestic demand. The Bank noted that growth was disappointing in the first quarter and that it is going to be slower than expected in the second quarter. In addition, Banxico took into account that inflationary pressures have receded and that inflation will remain low this year. Finally, the Bank concluded that they do not foresee any further rate cuts.
Regarding the Bank’s decision, Nomura Economist Benito Berber points out:
The decision was a complete surprise for several reasons. Banxico had not signaled the rate cut and, in fact, it had explicitly communicated its intention to not lower the policy rate below 3.50% arguing that that would have implied an ex-ante negative rate which was not justified given the expansionary fiscal policy and the expectation of economic recovery in the remainder of the year. Also Banxico’s board members were unwilling to lower the policy rate, per their own admission, because they believe that next year the US Fed would start increasing its own policy rate. Something clearly changed. […] Banxico mentions that the output gap has widened, that there are no inflation pressures, that the inflation expectations remain well anchored around the target, and more importantly that there have been inflows into the local markets. Also, Banxico believes that the normalization of monetary policy by the US Fed “would be gradual”. In our view, the combination of all these factors was, all together, enough for Banxico to surprisingly lower the policy rate.
Author: Ricardo Aceves, Senior Economist