MNI INTERVIEW: Banxico Should Be Cautious On Rate Cuts-Guzman

Mexico's central bank should wait for more evidence of falling inflation before easing monetary policy rather than rushing to cut interest rates and risk allowing price pressures to reignite, former Banxico Deputy Governor Javier Guzman told MNI.

"The statement by Banco de Mexico’s Board that they are going to maintain the monetary policy rate at the 11.25% level 'for some time' has been interpreted in general as a signal that a reduction of the reference rate is going to take place in the March 2024 meeting," Guzman said in an interview.

"I agree with members of the board who consider that this should be data-dependent. Headline inflation figures for the first fortnight of January were above expectations, and there is too much uncertainty and still important upward pressures on inflation to make a commitment on the date," he added, in reference to the minutes released in January.

Banxico maintained its target for the overnight interbank interest rate at 11.25% for the sixth consecutive meeting in December. Minutes released on Jan 4 held to the message that interest rates must be maintained at current levels "for some time." The board will meet again on Feb 8. (See MNI INTERVIEW: Banxico Cuts Coming Even If Premature-Ex-Deputy)

LESS COSTLY

A possible hawkish mistake by Mexico's central bank at the start of the easing cycle would be "much less costly" than a dovish overreach, said Guzman, who served as deputy governor until 2020. Banxico should only reduce its policy rate if inflation continues to decline as anticipated and inflation expectations do not deteriorate, he said.

"Given the risks, the board should err on the side of caution. Erring on the hawkish side would be clearly much less costly than the alternative," said Guzman.

He warns that, despite inflation dropping over the last year as the impact from the pandemic and Ukraine war shocks have eased, inflation, especially the core measure, still "remains too high."

"Inflation is expected to fall further this year and the next. However, at 4.9 and 4.8%, respectively at present, both headline and core inflation remain too high," he said. "Core services inflation has shown persistence and seems to be related to demand pressures, a fast increase in wages, and inertia resulting from high inflation expectations.”

The former Banxico deputy emphasized that officials' forecasts are distant from market projections. "While the central bank expects to reach the 3% inflation target in mid-2025, analysts' inflation expectations for the end of next year and for the long-term stand at 3.7%," he affirmed, adding that Banxico still "has a lot of work to do to strengthen monetary policy credibility."

FOMC EFFECT

After the FOMC statement on Wednesday, a federal funds rate cut in March "is unlikely," but the door remains open for reductions later in the year, noted Guzman, adding that this has implications for Mexico.

"As seen in recent weeks, the sensitivity of the Mexican peso to expectations of movements in the U.S. monetary policy rate is high, and this may have implications for inflation. Still, this is only one element to consider when deciding whether or not Banco de Mexico has to adjust its reference rate," he said.

"In the end, the crucial element is the current and anticipated evolution of both inflation and inflation expectations."