Mexico Central Bank Cuts Key Rate to Lowest Level Since 2016

(Bloomberg) -- Mexico’s central bank cut the benchmark interest rate to its lowest level in three-and-a-half years as the country falls into a recession that economists say will be the worst in decades. The peso strengthened following the unanimous decision by the board not to cut any deeper.

Banco de Mexico, led by Governor Alejandro Diaz de Leon, reduced borrowing costs by half a point to 5.5%, as forecast by 20 out of 22 economists in a Bloomberg News survey. One economist had predicted a 75-basis point cut and another saw a 100 basis-point drop.

The move followed two unscheduled rate cuts of half point each in March and April as the normally hawkish central bank moved quickly to contain the impact of the pandemic and plunging oil prices. Mexico faces an economic contraction that may reach as much as 12% this year, according to the most pessimistic forecast by BBVA analysts.

“I am surprised that the decision was unanimous, after some board members had hinted at the need to move faster,” said Alonso Cervera, chief Latin America economist at Credit Suisse Group AG. The board is “refraining from declaring victory over inflation despite the collapse in growth.”

The peso gained following the decision, and rose 1.3% on the day to 23.8690 per dollar.

MEXICO REACT: Banxico Avoids More Dovish Tone After Rate Cut

Unless the bank gives new guidance in upcoming days or weeks, the strong central scenario will be for a 50 basis-point cut at its next meeting on June 25, Cervera said.

In an interview on Thursday evening, Diaz de Leon said policy makers are taking care not to jeopardize financial stability as they cut interest rates to soften the shock from the virus.

The central bank board stated in the communique that accompanies its decision that it saw an economic slump deepening in the second quarter, along with a significant contraction in employment.

‘Monetary and Fiscal’

Central bank policy makers Thursday suggested that fiscal stimulus would be helpful to financial markets and the economy.

“Persevering in strengthening macroeconomic fundamentals, and adopting the necessary actions - both in monetary and fiscal areas - will contribute to a better adjustment of national financial markets and to the economy as a whole,” the central bank board wrote it in its statement.

The country suffered record losses of formal jobs in April as President Andres Manuel Lopez Obrador steadfastly resists major fiscal stimulus or bailouts for the nation’s largest companies.

The easing cycle has seen Mexican rates decline from 8.25% in less than a year, and is widely expected to continue. Swap markets are pricing a terminal rate near 4.2% in a year before staging a rebound.

Despite the pace of reductions, Mexico continues to maintain one of the world’s highest real rates in order to protect the Mexican peso and limit inflation.

MEXICO INSIGHT: Track the Recession -- High-Frequency Dashboard

But slowing inflation has bolstered expectations for easing, as prices fell 1.01% in April, the most for any one-month period since at least 1969. Meanwhile, the peso has lost nearly 22% of its value this year, but showed early signs of recovery in May, strengthening close to 1% as of Wednesday.

Apart from the rate reductions, Banxico has made a concerted effort to boost market liquidity, selling dollar credit using a $60 billion swap line with the Federal Reserve. The central bank has also increased sales of non-deliverable forward hedges.

©2020 Bloomberg L.P.