Mexico: Despite low inflation Banxico raises rates following the Fed's move
December 17, 2015
At its last monetary policy meeting of 2015, scheduled for 17 December, Mexico’s Central Bank (Banxico) raised the target of the overnight interest rate by 25 basis points to 3.25%, which was a decision widely expected by the markets. Banxico’s increase was the first since 2008 and came a day after the U.S. Federal Reserve decided to hike interest rates for the first time in seven years.
Banxico’s Board’s decision was unanimous and, even as declining inflation had called for maintaining the interest rate at a record low in December, monetary authorities went on to hike interest rates. Banxico stressed the importance of maintaining the alignment with respect to the U.S. in a context of strong volatility in financial markets and other major central banks’ more accommodative monetary policy positions. Mexico’s Central Bank made clear its intentions to follow the Fed’s moves, aligning its monetary policy meeting calendar with that of the Fed as well as placing the Fed’s decisions at the forefront of variables to watch when taking decisions regarding interest rates.
In its statement, Banxico signaled that the economy had expanded faster than expected, supported mainly by private consumption and investment. Regarding the evolution of inflation, the Central Bank went on to recognize that inflation had fallen more than expected in 2015 and stated that it expects inflation to increase gradually towards its inflation target of 3.0% at the end of 2016 and to stabilize around the target in 2017. Banxico said that while domestic conditions would seem to suggest that it would be convenient to leave the interest rate unchanged and not adjust it in the wake of the Fed’s move, not adjusting the overnight interest rate could further weaken the Mexican peso and fuel inflation.
Although the minutes of the 17 December meeting provided little explicit information regarding guidance about the future path of the interest rate, the general view among analysts is that Banxico will closely follow the Fed in the near term. Banxico stated that it would remain wary about the short-term rate differential between Mexico and the U.S. while the Bank simultaneously appears to be more confident on the country’s economic growth. Banxico mentioned that economic and labor market slack are diminishing, although not to the extent as to generate demand side inflation pressures in the months to come. On balance, the Bank sees that risks to the outlook remain unchanged over the previous meeting’s assessment, although the Bank underlined that further exchange rate weakness is likely to require monetary authorities’ attention.
Author: Ricardo Aceves, Senior Economist