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

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

The Central Bank’s board of directors decided, by a split decision, to lower the central bank’s key interest rate by 25 basis points to 10.75%. This is the second cut this year, after the 25 basis point cut in March.

In a statement announcing its latest cut, Banxico said the drop in core inflation “better reflects the inflation trend” than headline inflation, which is rising.

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

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

Banxico said its board “assessed the behavior of inflation and its determinants, as well as 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.

The bank said headline inflation is still expected to converge toward 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.

According to Banxico, upside risks include persistent core inflation, further foreign currency depreciation, greater cost pressures, climate-related impacts and intensified geopolitical conflicts.

He also noted that the Mexican economy slowed in the second quarter, “extending the weakness seen since late 2023.”

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

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

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

The central bank also said its board “anticipates that the inflationary environment could allow for discussion of adjustments to the benchmark rate” at future monetary policy meetings.

Interest rate cuts ‘make no sense’

Some economic analysts have said that the Bank of Mexico’s decision to lower its key interest rate lacks logic.

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

Banco de Mexico suffered the expected inflation. Now I expect a 4.4% increase for the last quarter of the year.
Perdón but it doesn’t seem like we’re hoping for greater inflation and correcting the interest rate 🤷🏻‍♀️ pic.twitter.com/N0koWmhYy3

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

In a later message, she described the decision as a “mistake” and said it could damage the central bank’s reputation.

Abraham Vela, an economist and academic, said the simultaneous increase in inflation expectations and the decline in interest rates constituted a “monetary aberration.”

Alfredo Coutiño, director of Latin America 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 reckless and demonstrates a lack of commitment to the overarching mandate of price stability,” he said.

“The monetary decision is totally incompatible with inflationary conditions. On the one hand, the Central Bank is “significantly” correcting inflation estimates upwards for the rest of the year and on the other, it is easing monetary conditions. Apparently, the monetary policy work of the three board members (who voted in favor of a cut) is not governed by the monetary mandate of price stability,” Coutiño wrote.

“Banxico’s sole mandate does not include economic growth or public finances as a priority,” he added.

Some analysts have predicted the central bank will cut its key interest rate today, but the majority of those polled by Citibanamex and Reuters expect the second cut of 2024 to come later in the year.

Peso strengthens after Bank of Mexico announcement

Reuters reported that the Mexican peso depreciated immediately after the interest rate cut announcement to trade at 19.01 per U.S. dollar.

The peso, however, later strengthened to reach 18.90 per dollar at 5 p.m. Mexico City time. That rate represents an appreciation of just over 2 percent for the peso compared to its closing position on Wednesday.

The decision by the Bank of Mexico to cut its key rate – which will take effect on Friday – will reduce the gap between the Banxico rate and that of the US Federal Reserve from 550 to 525 basis points.

The wide spread between the two rates has benefited the peso for a long time, as it has made Mexico an attractive destination for investors, including those who practice the carry trade. In this context, it is somewhat surprising that the peso appreciated on the same day that Banxico announced an interest rate cut.

Central Bank’s New Inflation Outlook

Banxico has raised its headline inflation forecasts for the current quarter as well as for the fourth quarter of 2024 and the first quarter of 2025.

• Q3 2024: forecast revised upwards to 5.2% compared to 4.5% at the end of June.
• Q4 2024: forecast revised upwards to 4.4% compared to 4% previously.
• Q1 2025: forecast revised upwards to 3.7% from 3.5%.
• Q2 2025: forecast maintained at 3.3%.
• Q3 2025: forecast maintained at 3.1%.
• Q4 2025: forecast maintained at 3%.

Core inflation forecast

Banxico made only one change to its core inflation forecast, setting a lower forecast than previously for the current quarter.

• Q3 2024: forecast revised downwards to 4% compared to 4.1% at the end of June.
• Q4 2024: forecast maintained at 3.9%.
• Q1 2025: forecast maintained at 3.6%.
• Q2 2025: forecast maintained at 3.3%.
• Q3 2025: forecast maintained at 3.1%.
• Q4 2025: forecast maintained at 3%.

Mexico Daily News