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After Banxico’s Board of Governors decided to cut its benchmark interest rate by 25 basis points after a 12-month pause in March, they held rates steady yesterday at the current level 11.00%, as we expected.
The decision didn’t necessarily come as a surprise to markets, however, as it was consistent with the Bank’s forward guidance that it is yet convinced that it can substantially withdraw the degree of monetary restrictiveness and general expectations to this extent given the strength of services inflation.
Perhaps most striking, especially in contrast to the previous decision, was the return to unanimity in the decision making after the first signs of dissent on tapering. This reinforces our theory that while there was conflicting evidence for rate cuts, which could lead to a bumpy period of easing, there remains unanimity on the prudent approach and the path of non-consecutive cuts that we anticipated could take place. That said, although there is agreement within the Governing Board on the need for a prudent stance, when it comes to further cuts, we suspect we will once again see conflicting views.
Where there seems to be unanimity, however, is on the balance of risks to inflation, which remains tilted to the upside due to persistence in core inflation, potential FX depreciation, and greater economic resilience as well as external factors.
While this, along with a material upgrade to their inflation forecasts where they now see headline inflation falling back to target at the end of 2025 as opposed to mid-2025 previously, suggests Banxico will likely hold at their next meeting in June, we think the upgrade to their inflation forecasts provides greater capacity for the data to undershoot on June 7th, leading Banxico to cut rates by a further 25bps at the end of the month. This view is confirmed by the fact that Banxico retained language from March that the Governing Board will remain vigilant and “assess the inflation outlook in order to discuss adjustments to the benchmark rate”.
In particular, the latest inflation data revealed that, although the disinflationary process had continued to advance during the first quarter, the pace of progress has been slowing in recent months, finally showing an acceleration in headline inflation in April.
Although core inflation, for its part, performed better in April, the recent pick-up in headline inflation and, above all, the persistence of core services inflation, point to a less favourable scenario that, in our view, justifies the “vigilant” and “cautious” approach that continues to dominate Banxico’s communications. Although the Governing Board acknowledges the progress of the disinflationary process, they point out that risks remain on the upside, in a context in which the labour market remains solid and the economy continues to operate with positive output gaps. Nevertheless, and although we believed that the flight to long MXN positions in the second half of April could set a more decisive tone at the Bank’s meeting, Banxico continue to see the relative strength of the exchange rate as a factor that will help mitigate some pressure on inflation. In any case, given that the peso has recently suffered the ravages of deteriorating risk sentiment, which we cannot rule out again in the near term, we believe that policymakers will closely monitor exchange rate developments, even if this is not currently a decisive factor to deviate from their monetary policy path.
That said, while this argues in favour of Banxico holding rates at the end of the quarter, we think it instead supports the strategy of rate cuts in non-consecutive meetings given the ex-ante real interest rate remains high, disinflation progress is still positive, and the economy is also seen slowing.
Overall, we think this stance of non-consecutive rate cuts from Banxico will remain supportive of MXN strength, especially heading into the upcoming elections where the prospective future leader will need to instead focus on the preparation of budgets with fiscal consolidation in mind. In comparative terms, a more sustainable debt trajectory and a higher and more navigable path for Mexican rates should see MXN remain strong in the coming months, especially against regional partners.
Author:
María Marcos, FX Market Analyst