For the first time in 42 months, the Bank of Mexico cut the policy rate amid a relatively low and manageable inflation environment. The move, according to the authorities, responds to a weak global economic environment and significantly loose monetary conditions in advanced economies that may create undesired imbalances to the Mexican economy.
IHS Global Insight perspective | |
Significance | The Central Bank of Mexico (Banxico) cut the rate from 4.50% to 4.00% at its March monetary policy meeting, the first change in the rate after three and a half years. |
Implications | The move to relax monetary policy will help expand domestic demand (consumption and investment) and will also prevent excess capital inflows that may put downward pressure on the exchange rate and reduce the competitiveness of Mexican exports. At 4%, the current policy rate is at its lowest level since July 2005 when Banxico started targeting the overnight interbank loan rate. |
Outlook | The central bank acknowledged that inflation may go above the upper bound of the targeted band (4%) in the coming months, which is consistent with the IHS forecast, so the likelihood of additional rate cuts is not very high given the prudence and passive attitude showed by the bank in the past three years. |
Inflation in February accelerates, annual figure remains well within target
In February, the National Consumer Price Index (INPC) increased by 0.49%, which represents an acceleration over the previous two months, although it is fairly manageable. Inflation in February was mostly driven by soaring prices in telecommunications, in particular tariffs for cellular phone services that skyrocketed by 27.9% and accounted for almost half of that month's inflation. Year-end sales had brought these tariffs down around 20%, and had also helped Banxico to meet its inflation target. As in previous months, gasoline prices went up almost 1%; these prices are controlled by the government, and the increase reflects a policy oriented toward eliminating subsidies and bringing domestic prices of gasoline more in line with international prices. Prices in the all-important food category were up only 0.04%, which confirms that the spike in food prices registered at the end of 2012 was just temporary and reflected the increase in food prices in international markets that occurred in the second half of 2012. As prices in international markets are levelling off and in some cases trending downwards, we expect food price stability in the upcoming quarters.
At the end of February, the 12-month inflation figure amounted to 3.55% – within the central bank's target. Banxico targeted inflation at 3% +/- 1 percentage point. Meanwhile core inflation (excluding volatile energy and food related prices) was 2.96%. Services in the core index posted an inflation rate of 2.21%, and the central bank follows this index as it fairly reflects domestic demand pressures or the lack of them. In February the producer price index (PPI) increased 0.38% and the annual PPI inflation amounted to 2.01%.
Banxico cuts policy rate after 42 months unchanged
The central bank has slashed the policy rate after keeping it unchanged for three and a half years; behind this decision there were exogenous as well as endogenous factors. The monetary authority assessed that the global economic environment is not only one of relatively slow economic growth but also there are significant risks that may further deteriorate the short-term outlook of the world economy. Also, central banks in developed economies – mainly in the US, Europe and Japan – have implemented significant monetary stimuli, what the IMF calls a "global liquidity flood", and Brazilian authorities refer to as "monetary tsunami". There may be a negative impact on Mexico from abundant global liquidity when foreign capitals searching for higher returns put downward pressure on the exchange rate and force the appreciation of the local currency to a point where the country loses external competitiveness. The bank is comfortable with current inflation levels and judged that inflationary expectations are well anchored. Finally, cutting rates will balance economic policy as the government has announced it will reduce the fiscal gap, so the monetary authority is responding to a restrictive fiscal policy with an expansionary monetary policy.
Outlook and implications
The Mexican economy decelerated in the second half of 2012 growing at an average rate of 3.2%, compared with 4.7% in the first half, and given that inflation is under control, the rate cut is fully justifiable given that the prevailing policy rate was high by current international standards. Mexico's economy has not only decelerated due to lower external demand but there are signals that the domestic market is cooling off; retail sales posted negative growth in December 2012 compared with a year earlier. This one-time rate cut puts the real rate at around 0.5%, which is prudent under current global liquidity conditions; Banxico has stated that this is not the beginning of an easing cycle and is not planning to execute further rate reductions, unless the domestic economy slows down sharply, which is not in our baseline scenario. The bank of Mexico is signalling that it is ready to take more drastic measures if the global economic environment deteriorates and is also confident about price stability. The size of the cut (50 basis points) is not unusual in the relatively short history of monetary policy using targeted interest rates. It is the first time the nominal rate has been as low as 4%, however, the real rate has even been negative in 2009-2010 when the monetary authority was trying to help the economy come out of the Great Recession. At IHS we do not foresee any rate cuts in the near term.