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Mexico Monetary Policy August 2018

Mexico: Banxico holds rates in August

At its 2 August monetary policy meeting, Banxico’s five-member board voted unanimously to hold the target rate at 7.75% after previously hiking rates ahead of the 1 July general election, a move broadly in line with market expectations. The decision came less than a month after the consequential vote and amid improved economic sentiment as greater political certainty and the recovery of the peso left officials with room to hold off on a further hike.

Given the bruising taken by the peso through mid-June over concerns surrounding the ongoing renegotiation of the North American Free Trade Agreement (NAFTA), as well as the impending vote, officials were almost certainly breathing a sigh of relief in August as the currency recovered significantly from its losses in the second quarter. That said, despite weaker upside risks to inflation in recent weeks as the currency strengthened, year-end expectations still ticked higher as the external backdrop grew more uncertain. Namely, the strength of the U.S. dollar and an unfavorable outcome on NAFTA each continue to pose upside risks to inflation. On the other hand, weaker growth domestically in the second quarter pushed officials to downgrade their full-year estimates, suggesting that upside risks to inflation this year will be almost entirely externally-driven rather than homegrown.

August’s communiqué largely kept the hawkish tone adopted ahead of the 1 July general election, suggesting that rate hikes are still on the table should the inflation outlook continue to deteriorate. Although the peso’s recent gains relieved some pressure, ongoing trade disputes with the U.S. could quickly fall apart and wreak havoc on the currency and, thereby, inflation. At present, FocusEconomics panelists see the peso strengthening through year-end and keeping a lid on inflation. That said, external risks persist, and most panelists see Banxico holding rates through year-end until some clarity on Mexico-U.S. trade relations emerges. By next year, both Banxico and FocusEconomics panelists see inflation receding, and, in the absence of external shocks, our panelists see room for Banxico to begin cutting rates.

Articulating the majority view, João Pedro Ribeiro, Latam Economist at Nomura, noted:

“All-in-all, we continue to highlight that MXN is a key variable for monetary policy in the current environment and meaningful weakening of the currency could very well lead to more hikes; a scenario that is connected to the uncertain outlook on NAFTA negotiations. However, we maintain our stance that domestic activity/inflation dynamics are such that there should be no need for additional hiking in the absence of a much weaker currency, particularly given that the base rate is already at contractionary territory. In this sense, we keep maintain our view for 2018-19 monetary policy following yesterday’s decision. We continue to expect stable rates this year before the beginning of a cutting cycle in 2019 (to 7.00%).”

Banxico officials will meet again at the beginning of the fourth quarter.

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