No, Banxico’s Rate Hike Has Not Started A Hiking Cycle

Summary

• Banxico’s surprise rate hike last month prompted the market to price in over 100bps in hikes over the next 12 months. We think such a pace of tightening is unlikely.
• If inflation surprises again in 4Q, we believe the central bank could hike another 25bps to anchor expectations. But there are no signs a hiking cycle has begun.

On 24 June, Banxico surprised the market with a monetary policy rate increase of 25bps. As the communique and meeting minutes noted, most members voted for the hike to anchor inflation expectations as inflation continued to surprise to the upside this year.

The reaction was stark. The market priced in over 100bps in hikes over 12 months, and analysts similarly revised their monetary policy expectations. Yet we think such a pace is unlikely. Rather, we believe Banxico could hike another 25bps to anchor expectations should inflation surprise again in 4Q21. But there are no signs a hiking cycle has begun, something the market is pricing.

The Inflation, the Hike, and the ‘Overreaction’

June’s hike up to 4.25% came only four months after the board cut the rate by 25bps to 4.0% and decided to hold the rate on two previous occasions. The preceding decisions were unanimous, but June’s was split: three for, two against, the latter wanting no change.

The hike followed inflation constantly surprising to the upside this year, with both core and non-core components pressuring up. Moreover, the board communique noted that, given the higher-than-expected inflation reading in 1H June, the bank had to revise its inflation forecast – less than a month after it published its 1Q21 quarterly inflation report. In effect, Banxico said they now expect inflation to reach the 3% YoY target only in 3Q 22, instead of 2Q 22, and reiterated that the balance of risks remains to the upside.

Finally, the communique noted that although Banxico believes the current inflation shocks are transitory, their magnitude, extent and persistence might contaminate inflation expectations. As such, most believed the hike necessary to anchor expectations.

The hike prompted quick revisions from the market and analysts. The next day, the market priced over 100bps in hikes over the next 12 months and continues to do so. Banxico’s latest survey reveals private analysts also revised up their monetary policy call. The survey’s median forecast increased from 4.00% to 4.88% for end-2021 and from 4.50% to 5.25% for end-2022, essentially expecting Banxico to deliver a hiking cycle with an additional 100bps in hikes between 2H21 to end 2022.

In a Bloomberg interview on 25 June, Deputy Governor Gerardo Esquivel said that the market may have overreacted, noting the communique was carefully worded to avoid implying a hiking cycle had begun. In his view, if inflation aligns with the new forecast announced in the communique, there is no need to expect more hikes. And he believes most of the shocks coming from commodity prices, in particular fuel, are starting to be contained.

Minutes Reveal Esquivel and Borja as the Dissenting Voters

The 24 June meeting minutes revealed the two dissident votes were from Esquivel and Deputy Governor Galia Borja, who replaced arguably the most hawkish board member, Javier Guzman, at the start of the year.

Esquivel’s vote revealed he questioned a hike’s effectiveness under the current scenario as he believed high inflation largely resulted from a base effect and supply shocks. Meanwhile, he highlighted the risks to growth. Currently, Banxico expects 6% real growth in 2021 with balanced risks. Yet analysts, according to the central bank’s latest survey, expect 5.8% and 2.8% real growth in 2021 and 2022, respectively.

More interestingly, the minutes show some support to Esquivel’s point in the Bloomberg interview. One member who voted for the hike noted it was not the start of a hiking cycle, instead framing it as rather a necessary adjustment to monetary policy given the revision to the inflation forecast. Moreover, the minutes do not indicate support for further hikes given the new forecasted path. Instead, most members seem open to further adjustment if inflation forecasts need further revision to the upside.

The board had the inflation readings for 1H June at the meeting. These show headline at 6% YoY and core at 4.6% YoY. Following the 1H June report, the latest survey shows analysts revised their inflation forecasts. The median for headline now stands at 5.6% YoY (up from 5.0% in May), with core at 4.74% YoY (up from 3.91%).

Banxico expects inflation to moderate in 3Q21 and then bounce back in 4Q21. Inflation for the whole month of June showed the start of some relief coming from the non-core component, in particular energy, that is likely continuing in July given the slight moderation observed in energy prices.

Banxico Will Likely Hold Fire Until the End of the Year

The next monetary policy decisions will come on 12 August, 30 September, 11 November and 16 December. After reading the minutes, we think the board will likely remain on the sidelines until the end of this year, when inflation could possibly surprise to the upside. If it does, we believe the central bank could hike another 25bps to anchor expectations. But despite the market pricing the start of a hiking cycle, we see no such thing.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)