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Mexico central bank holds benchmark rate following deal to replace NAFTA

Mexico's central bank kept its benchmark interest rate unchanged, citing an expected continued decline in core inflation and decreased trade uncertainty after the country reached a new deal with the U.S. and Canada.

Banco de México's governing board maintained the target for the overnight interbank interest rate at 7.75%. But unlike the monetary policy meeting in August, the decision to hold the rate steady was not unanimous, with one policymaker voting for a rate hike of 25 basis points.

The central bank said recent shocks such as higher-than-expected energy price increases indirectly affected the pace of decline in core inflation and delayed the convergence of headline inflation to the bank's target. However, these shocks were only transitory, and the expected trend for core inflation remains downward, the bank said.

"This has contributed to keep noncore inflation high for a long period. Although core inflation has been subject to the aforementioned indirect effects, projections that it will continue decreasing within monetary policy's period of influence are maintained," Banxico said in a statement.

Year-end headline inflation expectations rose to 4.50% in September from 4.25% in July, while year-end core inflation expectations fell to 3.53% from 3.60% over the same period, according to the central bank.

Expectations for headline inflation for the end of 2019 increased to 3.70% from 3.60% during the same months, and those for core inflation for the end of 2019 remained essentially unchanged. Medium-term and long-term headline inflation expectations stayed at about 3.50%.

On the trade and economic fronts, Banxico said the new deal replacing the North American Free Trade Agreement could have a favorable impact on markets and on the Mexican peso.

"Given the complex environment the Mexican economy faces, Banco de México's Governing Board considers that the balance of risks for growth continues biased to the downside," the bank said. "This bias has decreased at the margin as a result of the recently approved trade agreement with the United States and Canada."

The bank said recent data suggests that the Mexican economy expanded at the start of the third quarter following a contraction in the second quarter.

Despite reduced uncertainty over trade, the Mexican economy still faces the risk of tighter external financial conditions, as well as escalating global protectionist measures that could negatively affect inflation, Banxico warned.

"Under these circumstances, it is particularly relevant that, in addition to following a prudent and robust monetary policy, measures to foster greater productivity are adopted and public finances are consolidated sustainably," the bank said.