MexECON Blog

Central Bank Holds Rates at 3.00 Percent

In a decision on Friday, policymakers at Banco de México held their benchmark interest rate at a record-low 3.00%, unchanged since the last rate cut in June.  In their statement, the policymakers noted that Mexican economic growth continues to recover moderately from its soft spot over the last couple of years, driven mostly by strengthening exports and a rebound in private investment.  They took a more pessimistic view of consumer demand, saying that it was still not showing clear signs of recovery, and they said greater government spending has had only a limited impact on activity to date.  The remaining slack in the economy would therefore persist for a while yet.  According to the policymakers, there is no indication that the big sales tax increase in January 2014 or the recent plunge in the value of the peso has had any lasting impact on inflation expectations.  Because of the remaining slack in the economy, they believed consumer price inflation in Mexico would probably continue to fall toward their goal of 3.0% by mid-year, and might even drop below target by year's end.  They noted that increased interest rates in the United States and the ongoing weakness in global oil prices could lead to destabilizing volatility in the financial markets, but they suggested that the first line of defense against that risk should be tighter fiscal policy before tighter monetary policy.

Comment:  I continue to believe that Banco de México is being too pessimistic on the Mexican economy.  With the U.S. economy strengthening, the demand for Mexican exports should continue to rise, even as the domestic construction sector continues to recover.  The policymakers' pessimism on consumption spending seems especially misplaced.  After all, the sharp decline in Mexican unemployment over the last six months should prompt a gradual improvement in consumer demand.  Moreover, while the recent fall in the peso should help support Mexican exports, it could also have a positive impact on consumption.  With the dollar strong and the peso weak, the billions of dollars that Mexican workers in the United States remit back to their families at home (and that drug cartels send back to Mexico) should translate into many more pesos and much more purchasing power than in the past.  The Mexican economy could therefore strengthen more than Banco de México expects, though not necessarily dramatically.  The gathering strength in the economy could keep inflation higher than the policymakers anticipate.  If the Federal Reserve starts raising U.S. interest rates this year, it could also spark a sudden outflow of capital from Mexico.  Banco de México Governor Carstens has said that rising rates in the United States might require higher rates in Mexico as well, but the tenor of today's statement makes me think the central bank is a bit behind the curve.  It should probably be focusing more heavily on laying the groundwork for raising its benchmark rate in the coming months or quarters.

Patrick Fearon, CFA
Vice President, Fund Management

Benchmark Rate 1501

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