Mexico Rate Cut Pause Becoming More Likely, Central Banker Says

(Bloomberg) -- Mexico is increasingly likely to have to pause its 13-month cycle of interest rate cuts due to fast inflation, deputy central bank Governor Javier Guzman told Bloomberg News.

Space is “getting even more limited” for extending the current round of monetary easing after inflation sped past the top of the bank’s 2%-to-4% target range last month, Guzman said in a phone interview. Now would not be the right moment for Mexico to move to negative real interest rates -- borrowing costs adjusted for inflation, he added.

“The probability that we’ll have to take a pause has increased,” Guzman said Wednesday, adding that room for cuts has probably grown “much more limited” due to inflation and the possibility that Mexico keeps raising the minimum wage next year.

Last week, the central bank led by Governor Alejandro Diaz de Leon cut its key interest rate by a quarter point to 4.25%, the smallest reduction since February.

The central bank, known as Banxico, has slashed interest rates at 11 consecutive meetings from 8.25% in the deepest easing cycle since Mexico adopted a new reference rate in 2008. Nonetheless, it may not be enough to aid an economy that the bank expects will shrink as much as 12.8% this year, the most in almost a century, due to the coronavirus pandemic.

When announcing the cut, the bank said it sees inflation returning to its 3% target by the end of 2021, suggesting there may be some room left to lower borrowing costs. During the interview Guzman noted his concern that there was a “significant gap” between Banxico’s projections and those of economists recently polled by Citibanamex, who see longterm inflation at 3.5%.

“We still have an additional task to do, because we want long-term expectations to be at 3%,” he said.

With interest rates now only marginally above inflation, Guzman said he doesn’t see real negative rates as viable for Mexico at the moment due to rising prices.

Regarding the current crisis, “in Mexico the dominant effect has been these upward pressures on the inflation rate,” he said, pointing to supply chain issues, demand for medical supplies, and exchange rate movements.

Banxico is grappling with uncertainty caused both by external factors like the upcoming U.S. elections and internal risks such as the condition of troubled state oil company Petroleos Mexicanos, Guzman said.

‘Very Virulent’

Guzman concludes his term as a deputy governor at the end of this year, and due to age limits, the 65-year-old’s post can’t be renewed. This gives President Andres Manuel Lopez Obrador the chance to nominate another board member and thus have a majority of the five-person board tapped by him.

Mexico’s openness to the global economy means the bank could be quickly punished for shifting far from expected policies--and its hard-won international reputation could plummet fast.

“Markets would respond very fast. The reaction can be very virulent,” said Guzman, whom analysts see as leaning hawkish. The credibility “we have earned until now has cost many years and we have to remember that you can lose that credibility very fast.”

In recent presentations, Guzman urged a cautious approach to monetary policy. Before the latest rate cut, in August, Guzman said that space to reduce Mexico’s key interest rate wasn’t assured.

Guzman said he doesn’t have any plans on what he’ll do after he leaves Banxico.

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