After more than five years without a rate cut in Mexico, analysts are finally gearing up for an easing cycle. Banco de México (Banxico) moved interest rates from 8.25% to 8% in August and then lowered by a further 25bp in September after inflation had returned to the bank’s 2%-4% target range in June.
Now, according to Capital Economics, markets are pricing in a policy rate of 6% by the end of 2020.
President Andrés Manuel López Obrador praised September’s rate cut, but added that he would like Banxico to “be concerned about economic growth, as well as inflation”. Even certain analysts have been calling for the central bank to go dovish earlier.
“Banxico remains overly cautious in our view and strikes a still somewhat hawkish tone even after two members of the Board pushed for a larger cut,” said BBVA economists in Mexico Javier Amador and Carlos Serrano after the September cut.
Admittedly, the Mexican economy — hit by the renegotiation of the Nafta trade deal, other bilateral issues with the US, a change in government, an FX rate depreciation and an increase in fuel prices — needs all the help it can get.
Mexico narrowly avoided recession in the first half of the year, and Citibanamex’s latest survey of expectations shows that analysts are forecasting GDP growth of just 0.4% on average in 2019.
As it celebrates 25 years of independence, however, Banxico continues to strike a prudent tone.
“Clearly, we are not experiencing a run-of-the-mill business cycle and are dealing with circumstances of an arguably unprecedented complexity,” Alejandro Díaz de León, governor of Banxico, tells GlobalMarkets. “Some of the changes Mexico has faced are structural — such as moving from being an oil exporter to an oil importer.
“Nafta, which had become part of the status quo, was renegotiated, and this is also structural.”
The downturn is beginning to impact prices. Core inflation is expected to have fallen for the fourth consecutive month in September, complementing non-core inflation that hit a record low of negative 0.7%, and the headline print in the first half of September was 2.99% — the lowest in three years.
Easing external pressures, thanks to looser monetary policy in the US and other developed markets, were therefore a welcome development for Mexico’s outlook.
“One of the most challenging items for policy going forward is the larger than anticipated deceleration of the Mexican economy, which has increased the trade-off for monetary policy,” says Díaz de León.
Nonetheless, to ensure an orderly adjustment to these structural shocks, Banxico has had to “strengthen the macro mix”, says the governor. “When it comes to monetary policy, this means a strong stance and prudence,” he adds.
So while BBVA might feel that Banxico could cut a further 200bp without having an impact on the exchange rate, Capital Economics — which earlier in 2019 was on the dovish side of the consensus — believes that “most analysts have gotten ahead of themselves” with their 2020 outlooks.
“Given that the US Fed is only likely to make one more cut, we think that a much longer Mexican easing cycle seems unlikely,” says John Ashbourne, senior EM economist at the research firm, which expects the policy rate to end 2020 at 6.75%.
Díaz de León has not forgotten the “complicated” process of bringing inflation down from its December 2017 level of 6.77%, the highest print since the bank introduced its target range.
While he admits the bank does envisage a continued reduction in core inflation, Díaz de León highlights certain lingering upside risks. Wages remain higher than expected given the business cycle, for one.
“Furthermore, the FX rate has been volatile, and we have seen periods of risk aversion globally — associated with trade tensions, geopolitics, and global policy direction — that could affect us,” he says. “Also, remember the non-core component of inflation is at lowest ever, so may rebound somewhat.”
Moreover, Mexico’s growth problem is not recent, and hardly just a result of tight monetary policy. While much of Latin America enjoyed transformational economic expansion in the last two decades, average growth in Mexico since 2000 is just over 2.2%.
“For 20 years Mexico has endured very low average growth,” says Díaz de León. ”Consequences of trade tensions, in particular, have also led to softer levels of investment.”
Indeed, latest data for gross fixed investment show it fell 7.6% year-on-year in July, which Banorte said “reaffirmed [investment] as the weakest link in terms of GDP”.
This is where Mexico needs to focus its efforts, says the governor. “We need to improve conditions for investment and build confidence,” he says. “One key element is to improve governance and rule of law, trying to increase security and fight corruption and impunity.”
Given the headwinds that Mexico has faced, even analysts pushing for more dovishness acknowledge that Banxico has been a great asset in keeping to its dual mandate of price and financial stability in recent years.
“Promoting this stability is one of our most important contributions to Mexico,” says Díaz de León. “Having an independent central bank has played a crucial role in providing stability and avoiding balance of payments crises like we used to have.
“We must continue to show that short-term approaches quick fixes are — at best — mirages, and at worst a nightmare.”