Banxico rate cut sends wrong signal on inflation, Heath warns

The Bank of Mexico (Banxico)’s latest rate cut “confuses and sends the wrong message” to financial markets, Deputy Governor Jonathan Heath told Reuters in an exclusive interview. He stressed that inflation risks remain skewed to the upside.

3% inflation is less likely to be achieved following the recent rate cuts, Heath added. He also warned that signalling an extended period of unchanged rates limits Banxico’s flexibility should further tightening be required.

Main points:

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

3% inflation by end-2027 is less likely following the latest rate cut

Committing to an extended hold limits flexibility, particularly for rate increases that could prove necessary if inflation fails to ease or the US Fed continues raising its rate

200 basis points is the threshold below which a fall in the rate differential between the Fed and Banxico would be “Dangerous and irresponsible” if the US Fed raises rates at upcoming meetings

The foremost outstanding task is to establish exactly why the bank has failed to bring inflation to 3% and keep it there.

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Banxico: key questions

The Bank of Mexico’s mandate

Preserving the value of the Mexican Peso (MXN) and setting monetary policy are the responsibilities of Mexico’s central bank, the Bank of Mexico, also called Banxico. Its primary objective is therefore low, stable inflation within its target range. It aims for inflation at or near 3%, the midpoint of a tolerance band between 2% and 4%.

Banxico monetary policy and the Mexican Peso

Interest rates are Banxico’s principal monetary policy instrument. To curb above-target inflation, the bank seeks to cool the economy by raising borrowing costs for households and businesses. The resulting higher yields generally support the Mexican Peso (MXN), making Mexico more attractive to investors. Lower rates, by contrast, typically weigh on MXN. A key consideration is the interest rate differential with the USD: how Banxico sets, or is expected to set, rates relative to the US Federal Reserve (Fed).

The Bank of Mexico’s annual meeting schedule

Eight policy meetings take place each year at Banxico. Decisions by the US Federal Reserve (Fed) heavily influence its monetary policy, so its decision-making committee generally convenes a week after the Fed. This allows Banxico to respond to, and sometimes anticipate, Federal Reserve policy measures. Following the Covid-19 pandemic, for instance, Banxico raised rates before the Fed. The aim was to reduce the risk of a substantial fall in the Mexican Peso (MXN) and avert capital outflows that could destabilise the country.