Mexico: Banxico hikes policy rate for second consecutive time in February
February 8, 2018
Banxico officials unanimously decided to increase the policy rate 25 basis points to 7.50% at the Bank’s 8 February monetary policy meeting. The outcome was broadly expected by market analysts and came against a backdrop of multiple domestic and external risks and unanchored inflation expectations. The tone of the communiqué was broadly hawkish and built on comments made at the previous meeting in December that showed officials preferred to be exceedingly cautious over failing to tighten monetary conditions enough to contain second-order effects on prices.
The Bank viewed the deceleration seen in both headline and core inflation in January as positive and noted that it had followed a strong base effect and tight monetary policy, suggesting that these effects will continue to pull on inflation in upcoming months. This statement was, however, quickly followed by a string of risks that the Bank argued is keeping the balance of risks for inflation heavily skewed to the upside, indicating Banxico remains wary of developments on the price front and will act to contain renewed inflationary pressures.
In particular, officials noted that the peso could depreciate again following an unfavorable result from NAFTA talks, faster-than-expected tightening by the U.S. Federal Reserve or financial volatility stemming from the 2018 Mexican election cycle. The communiqué also mentioned that additional shocks in non-core prices could fuel stronger inflation, while an exceptionally tight labor market may fuel higher wage pressures and unanchor inflation forecasts.
A gloomy outlook over inflation was evident in the trajectory the Bank projects prices will follow. Banxico expects inflation to converge with its 3.0% target in the first quarter of next year, one quarter later than it had stated in the December communiqué. The change partially reflected stickier non-core price pressures than previously expected; increases in energy and food prices persistently overshot market expectations in recent months. However, the path assumes an orderly path for the exchange rate despite the aforementioned risks to the currency.
On the economic front, the Bank sounded surprisingly upbeat regarding the economy’s performance in the fourth quarter of 2017. Officials highlighted the strength in exports and private consumption, as well as the stronger-than-expected sequential pick-up in GDP in Q4 on the heels of solid growth in services. All in all, the Bank noted that, while the balance of risks to growth remains tilted to the downside, it has improved recently.
Despite the hawkish tone struck at this month’s monetary policy meeting, the Central Bank fell short of signaling any further interest rate increases may be around the corner. Instead, elevated uncertainty and softening inflationary pressures suggest Banxico will stand pat in upcoming meetings unless any materialization of the aforementioned risks warrants additional monetary tightening. The case for the Bank remaining on hold in the near-term is reinforced by the possibility that these events could lead to an appreciation of the peso, which would bring forward the convergence of inflation with the Bank’s target and would require a lower policy rate to avoid ex-ante real policy rates from shooting up.
Author: David Ampudia, Economist