A rate cut sends the wrong signal on inflation, warns Banxico’s Heath

Financial markets are receiving a confusing and wrong signal from the Mexican central bank’s latest rate cut, according to Bank of Mexico (Banxico) Deputy Governor Jonathan Heath. In an exclusive interview with Reuters, he said the decision “confuses and sends the wrong message” and stressed that inflation risks remain skewed to the upside.

The likelihood of inflation failing to reach Banxico’s 3% target has increased with the recent rate cuts, Heath added. He also warned that forward guidance signalling an extended pause in rates leaves less flexibility should further tightening be required.

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What are the key points?

With inflation moving upwards, Heath says the latest key rate cut “Confuses and sends the wrong message”

The prospect of inflation reaching the 3% target by end-2027 has weakened following the recent rate cut

A commitment to keeping rates unchanged for an extended period limits policy flexibility, particularly for increases that may be necessary if inflation fails to moderate or the US Fed continues raising its rate

He says it would be “Dangerous and irresponsible” if the US Fed raises rates at forthcoming meetings and the interest rate gap between the Fed and Banxico drops below 200 basis points

Understanding fully why the bank has not been able to bring inflation to 3% and keep it there remains the most important unfinished task.

Banxico: Frequently Asked Questions

What role does the Bank of Mexico play?

As Mexico’s central bank, the Bank of Mexico, or Banxico, sets monetary policy and works to safeguard the value of the country’s currency, the Mexican Peso (MXN). Its primary aim is therefore to keep inflation low and stable within its target range. This means inflation at or near 3%, the midpoint of a tolerance band running from 2% to 4%.

How is the Mexican Peso affected by the Bank of Mexico’s monetary policy?

Interest rates are Banxico’s principal monetary policy instrument. To restrain above-target inflation, the bank seeks to cool economic activity by raising rates, which increases borrowing costs for households and businesses. The higher yields associated with higher interest rates usually support the Mexican Peso (MXN) by making Mexico more appealing to investors. Lower rates, by contrast, generally weigh on MXN. A crucial consideration is the rate differential with the USD: how Banxico is expected to set rates relative to the US Federal Reserve (Fed).

How many meetings does the Bank of Mexico hold each year?

Eight meetings are held by Banxico each year. Decisions by the US Federal Reserve (Fed) have a significant bearing on its monetary policy, so its policy-setting committee generally meets a week after the Fed. This schedule allows Banxico to respond to, and at times anticipate, the Federal Reserve’s policy measures. Following the Covid-19 pandemic, for instance, Banxico raised rates before the Fed did. It sought to reduce the risk of a sharp depreciation in the Mexican Peso (MXN) and avert capital outflows that could destabilise the country.