Banxico reacts unexpectedly to a weak economy

MEXICO - In Brief 06 Jun 2014 by Mauricio González

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Banco de México surprised its domestic and foreign constituencies by reducing interest rates 50 basis points. For some time now, the central bank’s board has considered that inflation is under control as well as inflationary expectations, that have been reduced from an annual 4.1% at the start of the year to 3.8%, as reported in the latest monthly poll between economic analysts conducted by Banxico. The interest rate drop could be interpreted as a signal that Mexico’s central bank is convinced that international interest rates will stay low for longer than expected, a view recently supported by the interest rate measures implemented by the ECB, as well as the perception that the US economy may be losing steam. Domestically, Banxico’s decision coincided with relatively bad news from the cyclical indicators published by INEGI. The coincident indicator for March is still below its long term trend and diminished 0.05 points compared to February and the leading indicator for April, although in the recovery phase, augmented a negligible 0.03 points with respect to the previous month. Certainly lower domestic interest rates won’t harm economic activity, but they won’t encourage it as well, due to two main reasons: the lack of depth of Mexico’s credit market plus the fact that productive investment has stalled as a result of weak perspectives for domestic consumption (in turn affected by a lower personal disposable income of about 4% for upper middle class consumers, that resulted from the tax increase at the beginning of the year). Finally, some of the negative consequences of lower domestic interest rates are: a weaker peso, that benefits exporters, but harms importers unnec...