News & analysis

Yesterday, Banxico’s Board of Governors decided to hold its benchmark interest rate at 11% for the second consecutive meeting, having begun its easing cycle with a 25 basis point cut in March.

While the decision wasn’t necessarily a surprise for markets, with 25 out of 27 economists polled by Bloomberg looking for such an outcome, the vote split did tilt the decision in a marginally dovish direction, as Director Omar Mejia dissented in favour of a 25bps cut. That said, with the core of the committee favouring a hold, the decision continues to support our base case that Banxico’s easing path is unlikely to be smooth, with rate cuts unlikely to be delivered at consecutive meetings.

Outside of the vote split, the biggest surprise in Banxico’s decision was a cursory mention of the volatility in domestic financial markets following the 2 June presidential election and the domestic risks that could continue to weigh on the sustainability of monetary policy, not only through an exacerbation of fiscal risks, but also for the exchange rate. This adds to the growing body of evidence that suggests inflation risks are tilted to the upside, a view that is widely shared within the MPC.

This reinforces our theory that, while conflicting evidence on rate cuts will continue, which could lead to a period of easing with further dissent, there remains unanimity on the cautious approach and the non-consecutive path of cuts that we anticipated a few months ago.

As mentioned, the main common ground among policymakers continues to be the risks to inflation. While recent data have revealed that core inflation is moving positively towards the Bank’s target, and despite the balance of risks to economic activity being skewed to the downside, we believe that the Board will not want to take a decision too early. Given the uncertainty related to the domestic political transition and the lagged actions of the Federal Reserve, we believe that risks for the Bank are currently balanced and that data dependence, as well as political developments at home and abroad, will be decisive in anticipating future decisions.

This view is confirmed by the fact that Banxico has changed its language since March, now anticipating that the Board of Governors “anticipates that the inflationary environment will allow it to discuss adjustments to the reference rate”, rather than “will assess the inflation outlook in order to discuss adjustments to the reference rate”.

Overall, we suspect that Banxico is somewhat disengaging from the “vigilant” and “cautious” approach that it had taken throughout its period of pause at the terminal rate and since the first cut this year. While they maintain the view that risks are tilted to the upside, the high level of the ex-ante rate and the assessment of current inflation developments suggest that they are more comfortable than a month ago to start the easing phase per se. However, in our view, this does not mean that we will see a start of consecutive cuts at the next meeting.

We believe that, despite this slightly more optimistic approach, factors such as a solid labour market and the economy continuing to show signs of strength continue to weigh on the Bank’s reaction function. Developments in the foreign exchange market will also be a key consideration, with further peso weakness likely to lead Banxico holding rates at elevated levels for longer.

Overall, we believe that yesterday’s pause and the reinforcement that Banxico won’t embark on successive rate cuts anytime soon will be supportive for the peso. However, we remain cautious on USDMXN as the incoming administration’s intentions become clearer. Over the medium term, however, we are structurally more bearish on the peso’s fortunes, noting that the US elections pose another layer of uncertainty, with the presidential election likely to focus on immigration policy and trade relations, which could see Mexico caught in the crosshairs.

This will likely have a larger role in determining the USDMXN rate than Banxico’s policy path.

 

 

Author: 
María Marcos, FX Market Analyst

 

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