MexECON Blog

Central Bank Holds Rates at 4.50 Percent

In a decision on Friday, policymakers at Banco de México held their benchmark interest rate unchanged at 4.50%.  The benchmark rate has now been at that level for 34 straight months.  In their statement, the policymakers said the Mexican economy is continuing to grow well, in large part because renewed export strength has offset a modest slowing in domestic demand.  Nevertheless, they said the balance of risks for economic growth is tilted to the downside because of foreign factors such as the worsening debt crisis in the European Union.  The policymakers remained optimistic about Mexican price stability.  They noted that the acceleration in annual inflation during May primarily reflected high prices for fresh fruits and vegetables, and that "core" inflation was much lower.  The policymakers saw a slight uptick in prices for core goods, but they ascribed that to the recent fall in the peso.  In their view, the stability in prices for core services was evidence of very little domestic inflation pressure.  In fact, they said the balance of risks for inflation was to the downside because the peso, supported by Mexico's good economic fundamentals, was unlikely to fall much further, and because weaker economic growth overseas would hold down global commodity prices.  In this environment, the officials said the current stance of monetary policy was consistent with overall inflation eventually falling to their target of 3.0%.

Comment:  Banco de México's economic analysis seems generally accurate, but the policymakers' view of inflation risks still seems a bit too complacent to me.  With the Mexican economy continuing to grow at an above-average rate, and with unemployment continuing to fall gradually, producers at some point will probably try to pass more of their rising costs on to the consumer.  The most striking aspect of the statement was that it did not explicitly mention the policymakers' readiness to cut rates as insurance against the possibility of contagion from the European debt crisis, even though that crisis has recently turned much worse.  When the crisis intensified last year, the policymakers said much more clearly that they were ready to cut rates if necessary.  Because the peso has fallen so much recently, it may be that the policymakers are now concerned that such a statement would prompt another leg down in the currency, which could be enough to worsen inflation.

Patrick Fearon, CFA
Vice President, Fund Management

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