Mexico economy: Quick View – Banxico cuts rates for first time in almost four years

Event

In a somewhat surprising move, the Banco de México (Banxico, the central bank) lowered its reference interest rate by 0.5 basis points to 4% on March 8th, on the back of weakening growth and a stable outlook for inflation. The cut is the first in three years and eight months. Banxico had previously kept the reference rate unchanged at 4.5% since July 2009.

Analysis

Banxico had been debating cutting rates in response to the gloomy global economic outlook for some time, but four developments appear to have prompted it to take definite action now. The first is weakening economic activity. The second is the expectation that inflation will converge with the 3% target during the second half of the year, even if it increases to 4% in the next few months. The third is the perception that Banxico has tamed inflation, as reflected by well-anchored inflation expectations, negligible spillover effects from transitory shocks, a lower inflation-risk premium and a decline in the level, volatility and persistence of inflation. The fourth is the need to realign domestic monetary policy conditions with those prevailing abroad. Downside risks to growth presented by weaker economic conditions abroad are expected to continue in coming months.

Banxico seems convinced that even if growth continues at a moderate pace, this will not generate inflationary pressures. Moreover, board members appear to support a lower interest-rate environment as a way to shrink the gap between domestic and external monetary conditions, which has the potential to encourage capital inflows that would place further pressure on competitiveness. The move also, therefore, appears targeted at reducing currency appreciation pressures.

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