MNI INTERVIEW: Banxico Cuts Coming Even If Premature-Ex-Deputy

Mexico's central bank looks set to begin cutting interest rates in the first half of this year -- sooner than would be advisable -- because policymakers' defacto inflation goal seems closer to "around" 4.0% despite a stated official target of 3.0%, former Deputy Banxico Governor Manuel Sánchez told MNI.

"It is most likely that Banxico will start cutting rates in the first part of 2024, citing reasons such as achieved disinflation and the ‘inconvenience’ of maintaining ‘very’ high real interest rates,” he said in an interview.

“A member in the board of governors even claims to know what the ceiling for this variable is,” said Sánchez, who served at the central bank between 2009 and 2016, in a nod to the central bank’s December minutes.

Banxico last month maintained the target for the overnight interbank interest rate at 11.25% for the sixth consecutive meeting. Minutes released on Jan. 4th held to the message that interest rates must be maintained at current levels "for some time." (See MNI Banxico Review: Dec 2023 - Relatively Hawkish Tilt)

A key central problem for Banxico is that convergence to the target has historically been achieved only for “relatively short periods,” and the current disinflation has been “precarious,” said the former deputy, now an economic advisor to Spruceview.

Sánchez thinks the debate at Banxico over when to begin cutting rates is “premature." In his view, Banxico should consider rate cuts only when the annual inflation is on a clear path toward the permanent target of 3.0%.

CORE RIGIDITY

The former Banxico deputy said the trend of decreasing general inflation that began in October 2022 has been “mostly driven by the abrupt reduction of non-core inflation,” which even showed negative readings in mid-2023.

“Recently, we have seen the benign side of the non-core. Its fall has favored, in part, core inflation. However, the downward rigidity of core inflation has increased compared to what was observed before,” said Sánchez. “From October 2021 to December 2023, core inflation remained above 5.0%, versus an average of 3.8% during 2018-2020.”

The resilience of economic activity in Mexico in itself is good news, but he warns that some of this was driven by the fiscal impulse.

“In the current cycle, economic recovery was supported, especially at the beginning, by the global economic revival and, in particular, by that of the United States. However, since the second half of 2023, a driving factor has come from the increase in public construction. Although it is accounted for as 'investment,' its future performance is questionable,” Sánchez said.

“The extraordinary fiscal relaxation for 2024, aimed at unproductive works and subsidies practically impossible to reverse, constitutes not only a hurdle to Banxico's efforts to contain inflation but, above all, a serious government irresponsibility,” he added.

EXCHANGE RATE CONCERNS

Although Banxico officially says it does not pursue a specific exchange rate level, Sánchez noted some members of the board have recently defended a monetary policy that maintains a "competitive" differential between interest rates in Mexico and the United States and, in this way, contributes to the strength of the peso.

“It is reasonable to expect that possible cuts in the federal funds rate would provide reassurance to those members concerned about the exchange rate to vote in favor of reducing Banxico's reference interest rate,” he said. (See MNI INTERVIEW: Fed To Ease Modestly In '24-Ex NY Fed's Benigno)

The ex-Banxico official said a major significant risk related to the presidential election, in June, would be that the new government “has an economic policy agenda more adverse to progress than the current one,” that “would further deteriorate the potential economic growth of the country.”