MexECON Blog

Central Bank Cuts Benchmark Rate to 4.00 Percent

In a decision on Friday, policymakers at Banco de México cut their benchmark interest rate to 4.00% from 4.50% previously.  It was the first rate cut since a series of downward moves during the global financial crisis in 2008 and 2009.  To justify the cut, the policymakers put particular emphasis on the possibility that U.S. economic growth would weaken in response to tighter fiscal policy.  The policymakers said weaker growth abroad had already led to softer activity in Mexico itself, first in a slowdown in exports and more recently in weaker domestic demand and rising unemployment.  While the policymakers expected overall inflation to accelerate to almost 4.0% through much of 2013, they said that was primarily due to transitory price increases for non-core goods.  They expected inflation to resume falling toward their goal of 3.0% by 2014, owing to softer global commodity prices and weaker demand at home.  In further justification for the rate cut, the policymakers argued that relatively tame inflation over the last several years had helped create stable inflation expectations.  Finally, the policymakers argued that low interest rates abroad threaten to spur excessive capital flows into Mexico.  In their view, lower interest rates and the government's move to balance this year's budget would help forestall such destabilizing flows.  Nevertheless, the policymakers took pains to say that the rate cut was not the beginning of a series of cuts.

Comment:  With the Mexican economy showing weakness, and with loose monetary policy in many other countries threatening to produce a currency war, many observers expected a rate cut by Banco de México.  Nevertheless, the cut came earlier and was larger than many expected.  The justification that U.S. economic growth is weakening seemed questionable as the cut came on the same day that the United States reported a significant acceleration in job creation.  It may be that the Mexican policymakers have correctly foreseen that the recent tightening in U.S. fiscal policy will hurt growth in the future, but I suspect the overriding reason for their big rate cut was the fear of excessive capital inflows and a surging peso even as other countries are trying to push down their currencies.  If that really was the main basis of the decision, however, it may have backfired on them.  The Mexican stock market surged on Friday after the decision was announced.  That is likely to encourage even more inflows and a higher peso in the immediate future, at least until investors begin to see that the cut is evidence that the Mexican economy faces real threats, and the central bank may not necessarily be on top of the problem.

Patrick Fearon, CFA
Vice President, Fund Management

Benchmark Interest Rate 1303

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