Banxico Overconfident?

MEXICO - In Brief 25 Oct 2013 by Mauricio González

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Banco de México just announced a 25 basis point reduction in the Domestic Interbank Rate, to an annual 3.5%. It was an expected move by most market operators, i.e. 23 out of 24 participants of the latest Banamex Money Market Survey. Banxico justified this action based on the fact that domestic inflation is under control, as reported yesterday for the first half of October --annual 3.27% for Consumer Price Index (CPI) and  2.47% for core or underlying inflation--, both clearly below the 4% upper limit set by the authorities. Banco de México may have validated market expectations, even though its monetary policy actions may show inconsistency with domestic and international economy behavior.Banxico seems to be guided solely by domestic inflation, without considering that México is fully open to international financial transactions. This implies the central bank needs conduct monetary policy considering international interest rate perspectives as well as other factors that may hinge on country risk premium, like fiscal strength.Even though it’s not clear when will the Fed raise its short term interest rates, the only way for them is up. Lowering interest rates in México diminishes the difference with current as well as expected international rates. If Banco de México does not react timely to international interest rate movements (as evidence has shown during the last few years), the real exchange rate will grow, both in level and volatility, causing unnecessary distortions in international trade and domestic production. The lack of precise coordination between domestic and international interest rates is a burden the Mexican economy could do without.In today’s communique ...