Mexico Rate Hike, Inflation Outlook and Current Account
The minutes from the 29 September monetary policy meeting showed that the decision to increase the overnight rate by 50bps to 4.75% was unanimous. According to the minutes, all board members stated that given the rise in inflationary pressures, it was necessary to adjust the monetary policy stance. This adjustment aimed to offset such inflation pressures and to maintain inflation expectations anchored, as per the minutes.
Also, the majority of the board members agreed on the importance of conveying the message that the bank’s board will continue to monitor closely all inflation determinants in order to respond in a timely way, if they put at risk the achievement of the inflation target. In the policy meeting, “all board members emphasized the need to strengthen Mexico’s macroeconomic fundamentals” and the majority stated that “the central bank will follow a prudent monetary policy” to complement the expected measures on the fiscal front. The minutes reflected a debate on the degree of slack in the economy, for the first time in several quarters. Some board members said that the output gap remained negative; one said that it is clear that the output gap has widened recently, while another said that it is not viable that it will close in the short term. Some members, however, said that there is uncertainty about the degree of slack in the economy, with one of them saying that the output gap is close to zero. On the labor market front, some members noted that despite the drop in the unemployment rate, there are no upward pressures on wages; however, one board member said that several labor market indicators seem to show that the slack in the labor market is small. The majority of the board members made it clear that, until now, there have not been second-round effects in the price-setting process in the economy.
However, some members noted that inflation has been on the rise, mainly due to the impact on merchandise prices from the weaker exchange rate. The majority of the board members also noted that inflation expectations remain anchored, though some noted that expectations remain slightly above the 3.0% target. As it was noted in the policy statement, the majority of the board members acknowledged that the balance of risks to inflation has worsened. The majority highlighted the potential for additional peso weakness as one of the main sources of risk to inflation and inflation expectations. Another risk was one of sudden increases in agricultural prices, while some members acknowledged that another risk factor came from demand-side pressures on prices, given the uncertainty on the degree of slack in the economy. Finally, on the exchange rate, the majority of the board members attributed the recent peso weakness to domestic and external factors. On the domestic front, the majority noted the perception of the weakening in public finances as a factor affecting the peso, as noted by the persistently high public sector borrowing requirements and an accelerated increase in the public sector debt to GDP ratio, among others. Other factors that board members mentioned were the widening in the current account deficit and “the lack of complete information about Pemex’s business plan.” Among the external factors, all members highlighted the concerns from “the electoral process in the US and its possible implications for Mexico, which could be particularly important.” The majority of the board also noted the US Fed’s monetary policy measures as another relevant external risk factor, while some also noted lower oil prices as an additional factor.