On September 26, Banxico carried out the third cut in its reference rate of the year by a magnitude of 25 basis points, as planned. However, unlike those first adjustments in March and August, the central bank has now underpinned what it assumes will be a strategy of continued monetary easing. That is, the beginning of the cycle of interest rate cuts is more clearly seen. This article addresses some interesting topics that can help us identify what lies ahead with monetary policy in Mexico.
Complex inflation situation: where we come from
Mexico, like the rest of the world, has been fighting a battle against the significant inflationary effects caused by the coronavirus pandemic. First there were supply disruptions that caused an increase in prices. This was followed by new clashes due to geopolitical conflicts, highlighting the war between Russia and Ukraine. Subsequently, the recovery of the economy after a series of fiscal stimuli – highlighting strong spending in the United States – and a rapid opening in most countries resulted in pressures on the demand side.
Approximately two years ago, annual general inflation stood at 8.7% in Mexico, a level not observed in two decades. The United States and other countries experienced a similar situation. In response, Banxico carried out an important process of restricting monetary conditions, taking the rate from 4.00% in July 2021 to 11.25% in March 2023.
Monetary restriction helped contain demand pressures, while normalization in supply chains favored an environment of lower supply pressures. With this, a path of decrease in annual inflation began, both in general and in underlying inflation (that component of inflation that excludes the most volatile items, such as agricultural or energy goods).
Where are we standing?
Fortunately, the inflationary situation has shown important signs of improvement in the last 12 months despite some challenges that prevail for prices both in the world and in Mexico. An example of this was the last report for the month of September, showing a monthly increase in general inflation of only 0.05%, the lowest for that same month in the INEGI historical series. With this, annual inflation stood at 4.58%. Core inflation fell to 3.91% in its annual comparison, marking 20 consecutive months of decline and entering the range of variability that Banxico allows from 2% to 4% (around its goal of 3%). Likewise, when analyzing the 277 generics that make up the National Consumer Price Index, it is observed that only 45% now have annual increases above 4% (a number that fluctuated around 80% in September 2022), 25% of the components with annual inflations between 2% and 4% and finally 30% of them with increases below 2%. This situation, along with a moderation in economic activity and the start of the Fed’s rate-low cycle in September of this year, have supported Banxico’s strategy of cuts of 25 basis points in its decisions in March, August and September.
Despite this, it is important to highlight that there are still many risks in the outlook for inflation in Mexico, coming mainly from the volatility of the prices of agricultural and energy goods. Likewise, it is worth mentioning that, within underlying inflation, services continue to show persistence at current levels and have not decreased significantly, maintaining an annual inflation of 5.10%. This alludes to a demand that remains relatively strong from Mexican consumers and represents one of the most important challenges for the central bank today. Annual headline inflation is still not at the 3% target, which will imply that despite the additional cuts we could see in the reference rate in the coming quarters, monetary conditions will continue to be restrictive.
Where the price panorama in Mexico is headed
After some improvement in some items that have helped general annual inflation to decline after the temporary pressures observed in the summer, the outlook still shows some important challenges. This could imply that the annual metric continues at a level around 4.5% for several more months. Perhaps it could get closer to Banxico’s target of 3% towards the end of 2025 or even the beginning of 2026. It will also be important to analyze the behavior of underlying inflation, whose downward inertia has been clearer, especially because it is an indication of the inflation that we could see in the medium term.
Some factors that will probably play an important role in its performance will be economic activity (with signs of slowdown), the effect of fiscal policy (awaiting the strategy within the 2025 Economic Package that the Ministry of Finance will present to Congress for discussion and approval in November), the Fed’s monetary policy strategy (which after the sharp cut of 50 basis points in September could moderate them going forward) and some geopolitical factors (such as the elections in the United States or the conflicts in the Middle East).
Analyzing the narrative of the members of the Governing Board of Banco de México, through artificial intelligence models that use natural language processes to classify the bias of communication, we can infer that there is interest in continuing with monetary relaxation in a way gradual and orderly in the remainder of the year. This suggests possible cuts of 25 basis points in the November 14 and December 19 decisions. This could bring the actual rate ex ante (ie nominal interest rate adjusted by expected inflation in the following twelve months) from 6.5% currently to 5.4% at the end of the year, still in a zone of monetary restriction.
In conclusion, the recent performance of inflation in our country has helped Banxico to carry out adjustments in its monetary stance, with three interest rate cuts this year and probably another two more in the next two months. Even so, the price outlook continues to face some challenges that require prudent conduct of monetary policy, both in Mexico and in other parts of the world. With this in mind, further reductions in interest rates are expected from Banxico, the Fed and other central banks, but with a cautious view. The other big question that remains to be clarified is the terminal level of interest rates once the current cycle of reductions ends. Everything indicates that these equilibrium rates are probably a little higher than those observed for several years prior to the pandemic.
Contact:
Alejandro Padilla is Deputy General Director of Economic and Financial Analysis of Grupo Financiero Banorte. The opinions expressed in this document are the exclusive responsibility of the author and do not represent the opinion of Grupo Financiero Banorte or its subsidiaries or affiliates.
Twitter account: @alexpadillasan
The opinions expressed are solely the responsibility of their authors and are completely independent of the position and editorial line of Forbes Mexico.
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