Mexico: Muted Policy Reaction To Recession

The growing slack in economic activity and the stellar MXN performance should tip the balance in favor of another rate cut by Banxico this week. Concerns over core inflation and, especially, rising wages suggest however that monetary policy guidance should remain cautious, but our bias is for a deeper cycle than currently expected.

Economic recession calls for a longer rate-cutting cycle

The growing slack in economic activity together with the impressive outperformance of the Mexican peso should tip the balance in favor of another rate cut at Thursday’s monetary policy meeting. A 25bp cut would bring the policy rate to 7.0%, down from the 8.25% peak that prevailed during 1H19.

This would also mark the second consecutive rate decision in which Mexico's central bank (Banxico) does not follow the US Fed, which kept its policy rate stable two weeks ago, marking a more decisive decoupling and another reduction in the US-Mexico rate differential (see chart). 

Still, considering the growing output gap and the limited prospects for a recovery, in the absence of fiscal policy stimulus, Mexico’s monetary policy stance remains unusually restrictive. The contrast with the monetary policy stance adopted elsewhere in LATAM is especially noteworthy, indicative of the more substantial scope for monetary policy stimulus, when compared to its regional peers.

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Local market surveys suggest that the cycle should pause when the policy rate reaches 6.5%, ie, there would be only two additional cuts after this week. This scenario suggests that monetary policy would remain slightly restrictive in the foreseeable future. 

Policy catalyst for growth is still lacking

The Lopez Obrador administration continues to emphasize its conservative fiscal policy credentials and, as a result, continues to signal a broadly neutral fiscal policy guidance, with reduced scope for fiscal expansion.

This suggests that the overall policy mix should remain, on balance, slightly restrictive, further reducing prospects for an economic recovery in 2020. 

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