As inflation rises, Mexico’s central bank cuts interest rate to 10.75%

Global NewsXAugust 9, 2024Last Updated: August 9, 2024

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As inflation rises, Mexico’s central bank cuts interest rate to 10.75%

The Bank of Mexico (Banxico) announced a surprise cut to its key interest rate on Thursday, just hours after data showed that headline inflation reached its highest level in over a year in July.

In a split decision, the Banxico board voted to lower the central bank’s benchmark interest rate by 25 basis points to 10.75%. It was the second cut this year, after a 25-basis-point reduction in March.

In a statement announcing its latest cut, Banxico said that decreasing core inflation “better reflects the inflation trend” than headline inflation, which has been increasing.

It noted that the annual core inflation rate, which excludes volatile food and energy prices, declined for an 18th consecutive month in July to reach 4.05%.

The annual headline rate was much higher at 5.57%, increasing for a fifth consecutive month in July to reach its highest level since May 2023.

Banxico said that its board “assessed the behavior of inflation and its determinants, as well as of inflation expectations” before three of the five members, including Bank Governor Victoria Rodríguez Ceja, voted in favor of a 25-basis-point interest rate cut.

Fruit and vegetable market in Mexico with prices posted — Banxico said its decision was based on declining core inflation rather than headline inflation. Core inflation does not take into account food and energy prices due to their variability. (Cuartoscuro)

The bank said that headline inflation is still expected to converge to its 3% target in the fourth quarter of 2025, although it acknowledged that its forecasts for this year and next are subject to a range of upside and downside risks.

Banxico said that the upside risks include persistence of core inflation; greater foreign exchange depreciation; greater cost-related pressures; climate-related impacts; and the intensification of geopolitical conflicts.

It also noted that Mexico’s economy slowed in the second quarter, “thus prolonging the weakness that has been observed since the end of 2023.”

“The balance of risks to growth of economic activity remains biased to the downside,” Banxico added.

Victoria Rodríguez Ceja, governor of the Bank of Mexico, which recently announced an interest rate cut. — Victoria Rodríguez Ceja, governor of Mexico’s central bank. (Galo Cañas Rodríguez/Cuartoscuro)

The bank said that “although the outlook for inflation still calls for a restrictive monetary policy stance, its evolution implies that it is adequate to reduce the level of monetary restriction.”

“Thus, with the presence of all its members, the Board decided by majority to lower the target for the overnight interbank interest rate by 25 basis points to 10.75%,” Banxico said.

The central bank also said that its board “foresees that the inflationary environment may allow for discussing reference rate adjustments” at future monetary policy meetings.

The interest rate cut ‘doesn’t make sense’

Some economic analysts asserted that the Bank of Mexico’s decision to lower its key interest rate lacked logic.

Gabriela Siller, director of economic analysis at Mexico’s Banco Base, said in a post to X that it “doesn’t make sense” for Banxico to cut its interest rate given that it increased its forecast for headline inflation in the final quarter of this year to 4.4% from 4%.

Banco de México subió la expectativa de inflación. Ahora esperan un promedio de 4.4% para el último trimestre del año.
Perdón pero no tiene sentido que esperen una mayor inflación y recorten la tasa de interés 🤷🏻‍♀️ pic.twitter.com/N0koWmhYy3

— Gabriela Siller Pagaza (@GabySillerP) August 8, 2024

In a subsequent post, she described the decision as a “mistake” and asserted that it could diminish the central bank’s reputation.

Abraham Vela, an economist and academic, said that simultaneously increasing the forecast for inflation and lowering interest rates was a “monetary aberration.”

Alfredo Coutiño, Latin America director at Moody’s Analytics, wrote on X that Banxico had taken “an unnecessary risk.”

“In the face of turbulent financial conditions and deteriorating expectations for the peso, today’s monetary decision is imprudent and shows a lack of commitment with the top mandate of price stability,” he said.

“… The monetary decision is completely inconsistent with the inflationary conditions. On one side, Banxico ‘significantly’ corrects to the upside inflation estimates for the rest of the year and on the other it eases monetary conditions. Apparently the monetary [policy] work of the three members of the board [who voted in favor of a cut] is not governed by the monetary mandate of price stability,” Coutiño wrote.

“The sole mandate of Banxico doesn’t include economic growth or public finances as a priority,” he added.

Alfredo Coutiño, Latin America director at Moody’s Analytics, an analyst who commented on the interest rate cut — Alfredo Coutiño, Latin America director at Moody’s Analytics, called the rate cut and “unnecessary risk.” (Alfred Coutiño/X)

Some analysts predicted that the central bank would cut its key interest rate today, but the majority of those surveyed by both Citibanamex and Reuters forecast that the second reduction of 2024 would come later in the year.

Peso strengthens after Bank of Mexico announcement

Reuters reported that the Mexican peso depreciated immediately after the announcement of the interest rate cut to trade at 19.01 to the US dollar.

However, the peso subsequently strengthened to reach 18.90 to the greenback at 5 p.m. Mexico City time. That rate represents an appreciation of just over 2% for the peso compared to its closing position on Wednesday.

The Bank of Mexico’s decision to cut its key rate — which will take effect on Friday — will reduce the difference between the Banxico rate and the United States Federal Reserve’s rate from 550 to 525 basis points.

The large gap between the two rates has benefited the peso for an extended period as it has made Mexico an attractive destination for investors, including those engaged in carry trade. In that context, it is somewhat surprising that the peso appreciated on the same day that Banxico announced an interest rate cut.