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Mexico Monetary Policy April 2018

Mexico: Banxico pauses hiking cycle in April as inflation decelerates more than projected

At its 12 April monetary policy meeting, Banxico’s five-member board unanimously decided to pause the hiking cycle and maintain the policy rate steady at 7.50%, a move widely expected by market analysts. The reasoning behind the Bank’s decision followed lower-than-expected inflation in the first quarter and a steadier peso. Nonetheless, far from suggesting a less hawkish stance, Banxico emphasized that myriad risks are threatening both the inflation and growth outlooks. It also reiterated its readiness to hike the rate again, if risks to inflation materialize.

The communiqué that followed the policy meeting showcased Banxico’s more upbeat assessment of inflation. Officials noted that both headline and core inflation continued to fall through March on account of a tight monetary stance and abating price pressures last year, mainly related to pass-through effects from the weakened peso. In fact, headline inflation averaged 5.3% in Q1, below the 5.5% expected by Banxico in its last quarterly inflation report. However, and similar to the view expressed in the Bank’s last communication, favorable recent developments on the price front were quickly followed by a succession of risks that authorities argue is keeping the balance of risks for inflation titled to the upside.

Prominent among these were a further depreciation of the peso following an unfavorable result from NAFTA talks or an electoral upset, financial volatility stemming from the general election, and potentially tighter global financing conditions on account of faster-than-expected tightening by the U.S. Federal Reserve. As such, and despite its favorable assessment of current inflation dynamics, Banxico appears unwilling to let its guard down by signaling a less hawkish stance. On the contrary, the Bank restated its commitment to taking firm and timely monetary policy actions to ensure the anchoring of inflation expectations and the convergence of inflation to the Bank’s 3.0% target, currently expected by Q1 2019, which is unchanged from February’s press release.

Another indication that the Bank still has a tight bias in monetary policy was in its assessment of the labor market. Although officials have already noted in previous meetings the lack of slack in the jobs market, it added in this month’s press release a pledge to especially monitor the evolution of labor unit costs. This slightly hawkish amendment to the communiqué suggests that Banxico is increasingly worried about wage dynamics and their effect on overall inflation, which could lead it to respond with further interest rate hikes.

On the growth front, the Bank sounded cautiously more upbeat than in previous meetings. Officials noted that the economy had continued to grow in the first months of this year, mainly buttressed by growth in services and a modest recovery in industrial activity. It acknowledged a slower pace of growth for household spending, while stressing that investment levels improved somewhat early in the year. That said, the Bank kept the balance of risks to growth skewed to the downside, underpinned by political volatility both domestically and abroad.

All told, while Banxico is unlikely to ease its monetary stance anytime soon, waning inflationary pressures should give officials enough leeway to adopt a wait-and-see approach for the months to come. Although a busy political calendar could trigger some of the aforementioned risks and thus prompt a further tightening in monetary conditions, a recent string of positive developments on the NAFTA front has increased the chances of a successful renegotiation of the free trade deal. This could see the peso firming up more than currently expected, bringing forward the convergence of inflation with the Bank’s target and thus requiring a more accommodative monetary stance.

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