Mexico Signals Forthcoming Cut After Keeping Rate Unchanged

(Bloomberg) -- Mexico kept borrowing costs at a record high for a fifth straight meeting Thursday, as robust economic growth has stoked concern about above-target inflation, while hinting a cut is on the table in the next few months by changing its forward guidance.

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Banxico, as the central bank is known, held its key interest rate at 11.25%, matching the forecasts of all 28 economists in a Bloomberg survey and leaving it at the highest level since it started targeting inflation in 2008. The bank also said it will hold the rate at its current level “for some time,” dropping a more hawkish reference used in the previous four meetings about maintaining it for an “extended period” of time. In addition, it acknowledged that progress on the disinflation process “has been made.”

The change in the bank’s language suggests the Mexican central bank is more open to consider a rate reduction after refusing to entertain the idea for most of the year. The bank’s five-member board has maintained borrowing costs since March — following a 22-month, 725 basis-point hiking cycle — even after inflation peaked in the third quarter of 2022.

“The tone of the communique was less hawkish than expected,” said Gabriel Casillas, the head of Latin America Economics at Barclays Plc. The new language “really provided support to our call that the next rate change will be a rate cut of 25 basis point in March.”

The Mexican peso sank 1.5% to 17.79 per dollar, the biggest drop in three weeks, as traders reassess bets on when the policy-rate cutting cycle will kick off.

Click here for a side-by-side comparison of Banxico’s rate announcements

“The Board will thoroughly monitor inflationary pressures as well as all factors that have an incidence on the foreseen path for inflation and its expectations,” Banxico said in a statement accompanying its decision. “It considers that, in order to achieve an orderly and sustained convergence of headline inflation to the 3% target, the reference rate must be maintained at its current level for some time.”

What Bloomberg Economics Says

“A slight language tweak suggests that, after holding rates steady since May, policymakers are starting to think about an initial rate cut as they wait for more data. Persistent core inflation and risks from strong labor-market conditions and robust domestic demand — consistent with a widening positive output gap — are still constraints.”

— Felipe Hernandez, Latin America economist

— Click here for the full report

Hot Growth

Growth in Latin America’s second-biggest economy this year has far exceeded expectations, amid robust exports to the US and strong consumer spending in Mexico, delaying the prospects of a rate cut amid sticky price pressures. One Banxico policymaker, Jonathan Heath, suggested last month that the board might hold rates well into 2024.

After Thursday’s guidance chance, some analysts are bringing forward predictions of when Banxico would start an easing cycle.

“Domestic demand is starting to show signs of fatigue, and it’s better to prevent than to lament,” said Andres Abadia, chief Latin America economist at Pantheon Macroeconomics. “If the peso remains under control, a cut of 25 basis points could be around the corner in December, or we could see it in the first meeting of the next quarter.”

Preliminary third-quarter output data posted last week showed that the economy expanded 0.9% from the previous three-month period, higher than the 0.8% median estimate of economists surveyed by Bloomberg. From a year earlier, gross domestic product rose 3.3%, also above the median estimate, underscoring the strong demand helping to pressure consumer prices.

The US Federal Reserve decided last week to hold rates at a 22-year high once again. In his post-decision news conference, Fed Chair Jerome Powell hinted the US central bank may now be done. Banco de Mexico members have insisted they do not simply follow the Fed, but they have in the past generally keep an eye on the spread between the two countries’ rates to prevent massive outflows of capital.

“We’ll have to see if they do a fine adjustment or if they go directly to normalizing monetary policy conditions with consecutive cuts,” said Janneth Quiroz Zamora, director of economic research at Monex Casa de Bolsa, which is now predicting that the bank will make its first cut in February.

President Andres Manuel Lopez Obrador has increased spending on key projects and programs before general elections in June. Several of his major infrastructure projects, including a 1,500-kilometer (930-mile) tourist train in the Yucatan peninsula and an airport in the coastal town of Tulum, are scheduled to open in December, which has fueled a construction boom on top of private investment.

Aside from a brief stall in late September, inflation has slowed steadily since the end of April, reaching 4.26% in October according to data released earlier Thursday. While that’s a 32-month low, price gains remain above the target of 3%, plus or minus a percentage point, and are expected to finish 2023 at 4.60%, according to the most recent Citi survey of economists published Tuesday. Core inflation, which excludes volatile items such as fuel, slowed to 5.5%.

Read More: Mexico Inflation Hits 32-Month Low as Banxico Meets on Rates

Some Mexico watchers have speculated that Banxico could carry out a preliminary cut, then pause to take stock of the effect, rather than delivering a series of reductions as Latin American counterparts in Brazil, Chile and Peru have done in 2023.

Even so, the worsening global outlook might prompt other banks across the region to temper their easing cycles. The Citi survey released before Thursday’s statement shows analysts had expected Banxico’s first rate cut, of 25 basis points, in March.

Still, Carlos Capistran, chief economist for Mexico and Canada at Bank of America Corp., cautioned that the market shouldn’t be too quick to revise its forecasts of when the country’s easing would take place.

“We still see economic activity as too strong and services inflation as too high for Banxico to cut anytime soon,” he said.

The central bank has one more decision this year, on Dec. 14, before reconvening in early 2024 to assess the state of the economy.

--With assistance from Rafael Gayol, Alex Vasquez, Michael O'Boyle and Maria Elena Vizcaino.

(Updates with analyst comments from fourth paragraph.)

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