News & Analysis

At its March meeting, Banxico’s Board of Governors decided to cut its benchmark interest rate by 25 basis points to 11.00% for the first time this cycle.

This decision, while consistent with the Bank’s stance and general market expectations, was, as we noted, more balanced than ever. On the one hand, renewed progress on core inflation, weaker than expected growth in 4Q23, which is also showing through in 1Q24 activity indicators, and a high ex-ante real interest rate supported earlier easing. On the other hand, Banxico’s expressed concerns about upside risks to inflation, the lack of progress on services inflation, and the risk that markets would interpret the decision to cut as the start of a sustained easing cycle, kept the door open in our view for Banxico to use the March meeting to adjust its forward guidance, clarify its implied reaction function, and point towards rate cuts in May when it also updates its economic projections.

This dichotomy has been revealed not only in the dispersion of analysts’ and traders’ expectations, but also within the Governing Board itself.

Throughout Banxico’s period of pause, the decision not to alter rates had been taken unanimously by the five members of Banxico’s Board of Governors, including Governor Victoria Rodriguez. However, at yesterday’s meeting we saw the first clear sign of a divergence of views, with Deputy Governor Irene Espinosa voting to keep the interest rate at 11.25% in March.

This reflects the conflicting evidence to cut rates and compounds the mixed messaging in the February statement, where Banxico moved from a higher for longer to a data dependent stance but also stressed upside risks to their inflation forecasts. As a result, Banxico’s latest decision is unlikely to be the start of an uninterrupted easing cycle, but the first rate cut along a bumpy path.

Inflation data since the February meeting have not mitigated these upside risks, as evidenced by the persistence of core services inflation

While annual headline and core inflation rates showed disinflationary progress in February, which in isolation suggested that Banxico could cut rates with confidence, services inflation and signs of labour market tightness suggest that upside inflation risks remain prominent, a point made clear in the March statement. That said, Banxico still view this as a risk, not a base case.  For reference, Banxico revised its Q1 inflation forecast marginally from 4.7% to 4.6%, although this was offset by an upwards revision to its year-end forecast from 3.5% to 3.6%.

While the latest headline inflation data suggest that Banxico’s Q1 average rate may be correct, in the absence of monthly data for March, the much faster pace of core inflation suggests that headline inflation may struggle to reach 3.5% by the end of the year unless policy remains tight for longer.

Banxico remains cautious despite starting to ease 

As we anticipated in our forecast for the decision, there was a credible risk that markets would ignore Banxico’s concerns about inflation persistence and price in much looser policy going forward if there was a first cut in March, something that led us to tilt our balance in favour of a first cut in May. However, the fact that the Board of Governors no longer holds a unanimous view on rates and that they have expressly acknowledged the persistence of upside risks to inflation, coupled with a clear guidance that policy will be data dependent, has prevented markets from taking such a view. These hawkish undertones to the decision to cut also supports our view that we are likely to see cuts in non-consecutive meetings, as such as stance runs the risk of policy excessively loosening, causing the economy to reaccelerate at a time when services inflation remains high and the labour market is tight.

In short, Banxico’s decision was able to satisfy the advocates of a cut in March and those who were betting on a possible later start given the recent data, and in doing so avoided the risk that the markets would interpret the decision to cut as the start of a sustained easing cycle, which could lead to an over-relaxation of financial conditions in Mexico.

This outcome has also been favourable for a MXN, which barely responded to the decision. Overall, we maintain our view that a cautious Banxico, despite the cut, is supportive enough for the USDMXN to continue to trade around current levels, by keeping the peso’s relative carry levels intact.

 

 

Author: 

María Marcos, FX Market Analyst

 

 

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