Mexico: Mexico's Central Bank maintains rates while facing a dilemma regarding what action to take, if any
April 30, 2015
Mexico’s Central Bank (Banxico) is facing a dilemma: the deceleration in economic activity and the gradual fall in inflation suggest that the Bank should keep the main monetary policy rate unchanged—or even cut it—in order to propel economic growth. However, an episode of capital flights provoked by financial instability that was driven by normalization in U.S. monetary policy suggests that the Bank should take action and raise the policy rate in order to contain volatility in the foreign exchange market. For now, Banxico has decided to maintain the overnight interest rate at 3.00%, a decision the Bank made at its 30 April monetary policy meeting, as the economy has been softening and inflation is gradually converging to its target.
Banxico’s dilemma was clear in its latest monetary policy meeting statement in which the Bank stated that, “the economy’s current cyclical conditions are showing weakness, overall inflation is practically within the target, core inflation and its two main components of goods and services are staying below 3 per cent, and inflation expectations remain anchored. On the other hand, as the Mexican economy is closely integrated into the global economy, particularly that of the U.S., monetary policy actions in that country could have important repercussions on Mexico’s exchange rate, inflation and inflation expectations.” Monetary authorities also stated that they will therefore monitor the current inflation determinants as well as inflation expectations in the medium- and long-term, but that they will keep a close eye on the evolution of the United States’ monetary policy.
Uncertainty remains regarding what the Federal Reserve will do next. The Fed has indicated thus far that a decision to raise interest rates is data dependent; the latest data signal that the U.S. economy slowed down in the first quarter of the year. However, in its latest monetary policy statement, the Fed indicated that the slowdown was due to transitory effects, namely severe weather conditions, a strong dollar and low oil prices, and left open the possibility of raising interest rates. The persistent unanswered question is whether the Fed will hike interest rates in the coming months or at the end of this year as this decision will have an important impact on Mexico’s monetary policy.
Author: Ricardo Aceves, Senior Economist