Economics: The risks of further rate cuts

MEXICO - Report 17 Feb 2020 by Mauricio González and Francisco González

Banco de México’s decision last week to implement its fifth consecutive rate cut in as many meetings validates the fact that interest rates remained high in light of inflation estimates and global monetary policy trends. In the statement that accompanied the rate announcement, Banxico cited continuing uncertainty, and announced that in its upcoming Quarterly Inflation Report it would be moderately raising its inflation estimate and lowering its GDP forecast from where they were in the previous report three months ago.

Of course, consumer inflation remains well within the target range, although core inflation is still a point of concern as it has been stubbornly high for some time despite the roughly half-year-long easing cycle. The peso has also been gaining ground against the dollar since the end of last year in response to considerable foreign currency inflows chasing the higher yields available in Mexico.

But there are many risks Banxico must take into account before considering any further easing moves, especially factors that could help generate an acceleration of prices. In addition to core inflation’s resistance to converging with the 3% target given the number of price components that are insensitive to the monetary policy rate, there is the trend toward more pronounced wage gains following the two unusually large minimum wage increases of the last two years, pressuring production costs and potentially input prices. In addition, we could see the peso lose ground in response to external factors, and there is the prospect of a deterioration of public finance in response to falling revenues as the economy has essentially flat-lined for the past year.

Employment levels have deteriorated as growth in formal sector jobs continues to slow, and the underemployment rate has remained around 8%, a full percentage point over the 2018 average. And in keeping with historical trends, central bank rate cuts do not have the desired effect on investment and private consumption as banks respond by paying their depositors lower rates while their lending rates remain unfazed.

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