Banxico Expected To Keep Rates At 4%, But A Hawkish Pivot May Support The Mexican Peso

The Bank of Mexico (Banxico) will announce its June monetary policy decision on Thursday. The institution led by Alejandro Diaz de Leon is expected to stand pat and leave the overnight rate unchanged at 4.0%, thus keeping it steady at that level for the third consecutive meeting.

In view of the increase in consumer prices caused by supply and demand factors, Banxico could adopt a more cautious tone and reiterate that the inflation path remains skewed to the upside. As a side note, in its latest quarterly report, the central bank revised higher its CPI projection for 2021, raising its forecast to 4.8% from 3.6%, significantly above the upper limit of its target range at 4%.

With mounting inflation risks, including a rise in short-term expectations, and a more balanced outlook for economic growth aided by strong external demand and accelerating COVID-19 vaccination rates, it would not surprise if Banxico began to pave the way for some policy normalization, following in the footsteps of other emerging market central banks, such as Brazil’s COPOM.

An outright hawkish tilt in its forward-guidance or a divided decision could be seen as positive catalyst for the Mexican peso mid-term. Over the longer horizon, however, any signals or message conveyed by the board now are likely to be irrelevant as the bank will have a new governor in 2022. Early this month, President Andres Manuel Lopez Obrador ruled out a second term for Diaz de Leon when he finishes his tenure in December and nominated current Finance Minister Arturo Herrera to lead the institution. With Herrera at the helm of monetary policy, Banxico could take on a dovish lean, although it is too soon to draw firm conclusions.

In any case, in the very short term, the Mexican peso will be more sensitive to external factors such as the dynamics of US Treasury yields and the tone of the market in response to the Fed's tightening bias. That said, if risk aversion spikes again like last week and panic-selling sets in, EMFX could suffer heavy losses, pushing the USD/MXN exchange rate towards the 21.00 or even above that. Typically, when risk-off sentiment takes hold, traders turn to the safety of the US dollar, unwinding riskier positions, an scenario that undoubtedly exacerbates volatility.

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