The Bank of Mexico stepped in yesterday with a unanimous inter-meeting decision to cut the benchmark interest rate by 50 basis points to 6%. Yesterday’s decision adds to the previous 50bp emergency cut on March 20th and continues the theme of gradual easing which began last August when rates were at 8.25%. Banxico emphasized that macroeconomic prospects are markedly biased to the downside, with forecasts of an economic collapse over 5% year-on-year in the first half of 2020.
The inflation outlook remains highly clouded by pressures acting in opposite directions – economic slack and the drop of energy prices to the downside and sharp currency devaluation to the upside – but on balance, price growth should continue to slow down. Looking forward, Banxico should continue its path of gradual monetary easing, with cuts of another 200 basis points already priced in by markets over the course of the next year. However, high risks of further currency and/or capital account losses will prevent Banxico from abandoning its rather conservative approach.
Even with a benchmark rate of 4.5%, our forecast for policy for year-end, the benchmark interest rate will sit only slightly below the estimated neutral rate of 4.8%.
Although this policy stance would still provide MXN with a relatively high spread against its main counterparts, carry trade attractiveness will play a limited role in supporting the peso under current market conditions.
In addition to interest rate cuts…
Banxico also implemented measures aimed at easing liquidity conditions in internal markets and expanding credit channels to mitigate the economic impact of coronavirus, with special emphasis on small and medium businesses. The measures, valued at MXN750 billion (roughly US$30bn) include facilities for the repurchase of long-term government and corporate securities, debt securities swap windows, and commercial and development banks lending to SMEs. Among the measures, Banxico will also allow currency exchange hedges settled by differences in USD with foreign counterparts to be traded outside of Mexican market’s hours, crucially aimed at reducing the sharp FX volatility. Despite these decisive steps by the central bank, this is the first time the Mexican peso has not reacted favorably to Banxico’s easing since the bank began monetary normalization last year. In turn, the downward trend of the peso answers to the steady decline in international oil crude prices, amid the dramatic recessionary environment facing the global economy.
The Market reaction suggests a lack of confidence on the extent to which monetary policy can help mitigate the sharp crisis the Mexican economy is embarked upon.
Both headline and stickier core inflation are leaving Banxico a large room for stimulus
Author: Olivia Alvarez Mendez, FX Market Analyst