MexECON Blog

Central Bank Holds Rates at 3.50 Percent

In a decision Friday, policymakers at Banco de México held their benchmark interest rate unchanged at 3.50%.  The benchmark has been at that level since the last rate cut in September.  In their statement, the policymakers said the Mexican economy is continuing its gradual recovery, mostly due to stronger external trade and a modest improvement in some aspects of domestic demand.  The policymakers saw the beginnings of a rebound in domestic consumption and public spending, though the improvements have not yet boosted investment.  The policymakers also noted a sharp rise in Mexican inflation at the end of 2013, but they ascribed it to temporary jumps in some fresh food prices and an upward adjustment to public transit fares.  They forecast that a series of tax hikes on January 1 would keep inflation around 4.0% in the first months of 2014, but they expected the rate would then trend down toward their goal of 3.0% in 2015.  Nevertheless, the policymakers promised to remain attentive to the risk that higher taxes and the falling currency would keep inflation higher than expected.

Comment:  With its decision to hold rates steady in the face of the recent broad sell-off in emerging market currencies, Banco de México is expressing its confidence that global investors will eventually come to appreciate the country's relatively good economic fundamentals.  Countries such as South Africa, Turkey, and India all have problems such as slowing growth or big trade deficits.  It therefore seems reasonable that investors would pull capital out of those countries, and their currencies, as the U.S. Federal Reserve starts to tighten monetary policy.  All three of those countries have been forced to raise interest rates over the last two weeks in order to limit the capital outflows.  In contrast, Mexico's economic growth seems to be accelerating after a soft spot in 2013.  Its trade balance has moved into surplus, and its fiscal deficit and public debt remain quite modest.  Banco de México would like to keep rates steady to promote a more vigorous acceleration, but the problem is that investors may continue to sell emerging market assets indiscriminately.  As the saying goes, "The market can stay irrational much longer than I can stay solvent."  If the rout in the emerging markets continues or intensifies, Mexico's policymakers eventually may be forced to raise rates like their counterparts in Africa and Asia. 

Patrick Fearon, CFA
Vice President, Fund Management

Benchmark Rate 1401

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