Banxico To Maintain A Cautious Stance

Banxico is expected to continue its easing cycle with another 25bps rate cut to 7.0% on Thursday. All but one of the 23 respondents in the latest Citibanamex survey expect a 25bps cut and the market is fully priced for 25bps. This will make the fifth consecutive rate cut from Banxico but will still leave the policy rate amongst the highest in EM.

We expect an unchanged vote split (4-1) in favour of a 25bps cut, accompanied with a dovish tone given weak growth, a highly restrictive monetary policy stance (real rates are at ~4%), and reduced domestic uncertainty creating a ‘window of opportunity’ to cut rates ahead of a relatively busy calendar in the second half of the year.

Sticky Core Inflation to Guide the Pace of Easing

Core inflation remains sticky despite a widening output gap, hitting a 4-month high of 3.7% YoY in January, versus a 3.0% central bank target. While this could mark a high for the year – given the impact from earlier one-off price / tax increases and decelerating services inflation – the potential impact from the minimum wage increase will remain uncertain until the end of March. Moreover, survey-based inflation expectations for 2020/21 continue to be stubbornly above the midpoint of the central bank’s target.

Recent comments from Board members have reaffirmed the likelihood of a “prudent” approach, and not a larger 50bps cut that some had voted for in each of the past three meetings. Deputy Governor Heath clarified his cautious stance in an interview with a local news outlet, noting that persistent upside risks to core inflation and a Federal Reserve on hold motivated his decision to vote for a 25bps cut at the December meeting. Additionally, Deputy Governor Guzman mentioned that Banxico risks losing credibility (by not meeting inflation targets) if it is not cautious with monetary policy. Governor Diaz de Leon echoed language in the last statement by recognizing both core and headline inflation could push above forecasted levels due to cost-related pressures from minimum wage revisions.

External Risks to Financial Stability Have Increased at the Margin

The peso has outperformed so far this year gaining around 1.5% versus the USD compared with weakness in BRL and ZAR as well as for several Asian currencies given concerns over the coronavirus outbreak. MXN has benefitted from high carry with real rates well above elsewhere in EM. Given Banxico’s attentiveness to financial stability risks, including the passthrough from FX weakness, as well as the consensus expectations of a cautious approach, Board members are likely to favour continuity in their policy stance (i.e. another 25bps cut) to avoid elevating investor uncertainty and potentially triggering outflows.

Chart 1: Real Rates in Mexico are Higher than in Other Major EMs

Source: Macro Hive, Trading Economics

Note: Real rate calculated as central bank policy rate deflated by YoY CPI. Data as at 11 Feb 2020. *Dec 2019 CPI used for South Africa, Malaysia, Poland, India, and Hungary. All others Jan 2020 CPI.

Economy Remains Weak, But Early Signs of ‘Green Shoots’

Latest data show the economy contracted 0.1% last year and this year’s growth is now expected at just 1.0% by analysts, below the median 1.3% forecasted by Banxico in its last Quarterly Report. While sluggish domestic activity will put downward pressure on core and headline inflation, there have been a number of positive developments recently which are more supportive of the outlook. These include: (i) favourable signals in latest manufacturing and non-manufacturing PMIs; (ii) USMCA ratification and de-escalation of trade conflicts and (iii) a US manufacturing sector that is showing signs of improvement. Nevertheless, the balance of risks for growth – despite showing signs of improvement – remain tilted to the downside.

Uncertainties to Escalate in the Second Half of the Year

The turn of the year marked a reduction in a number of domestic uncertainties, specifically on fiscal targets and USCMA ratification. This period of reduced domestic uncertainty, albeit interrupted by the heighted risks from the coronavirus outbreak, is likely to be a stark contrast to the second half of the year given the US elections, Pemex and sovereign downgrade risks (Moody’s decision due no earlier than July 2020), and Banxico’s Board configuration changes.

As such, we see Banxico capitalising on this ‘window of opportunity’ to continue cutting rates in the first half of the year, whilst maintaining a cautious approach, i.e. -25bps in February, March and May. With limited evidence to suggest another Board member will join Deputy Governor Esquivel in voting for a 50bps cut, and the inflation-related uncertainty, the risk of a more aggressive easing remains limited.

Harshal is a research analyst at Macro Hive. He has spent 1 year working as a macro analyst at a fintech startup, specialising in emerging markets. He graduated from Cambridge University with a degree in Economics, and is currently pursuing the CFA charter.

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