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Mexico’s central bank made a decision to cut its benchmark interest rate by 25 basis points on Thursday amidst global volatility that has impacted the peso.
The Bank of Mexico’s board voted 3-2 to lower the benchmark rate to 10.75 per cent. Despite the divided vote, the rate-setters acknowledged the challenges faced by the country due to recent global financial turmoil and prolonged economic weakness.
The board stated, “The balance of risks to growth of economic activity remains biased to the downside.”
Following the decision, the peso saw a strengthening against the dollar, reaching 18.9 in the aftermath.
Although Mexico is considered a potential beneficiary of nearshoring supply chains closer to the US, there has been no significant surge in investments. Analysts predict modest growth rates of 1.8 per cent this year and 1.6 per cent in 2025, according to a central bank survey.
Various factors such as a strong currency affecting exports, proposed constitutional changes, impending government spending cuts, and uncertainty surrounding the US election are contributing to the challenges faced by Mexico.
Gabriel Lozano, economist at JPMorgan, expressed concern over the cooling economic activity in multiple areas even before the US economic conditions started to slow down.
As left-wing President-elect Claudia Sheinbaum prepares to take office in October, she will need to address the deteriorating economic situation while tackling the highest budget deficit since the 1980s.
In recent years, Mexico’s peso has been a popular choice among investors due to its high interest rates. However, the peso has depreciated by 11.2 per cent since the left-wing party’s victory in June elections.
Concerns about a US recession, Mexico’s main export destination, have added to the currency’s volatility, with the peso hitting a low of 20.04 against the dollar on August 5.
Despite exchange rate fluctuations, Banxico’s decision to lower the interest rate was not directly influenced by this factor, according to analysts.
Liam Peach, senior emerging markets economist at Capital Economics, suggested that the central bank’s easing cycle would progress gradually.
In response to the pandemic, Latin America’s central banks took early steps against inflation, with the Bank of Mexico raising rates in mid-2021 before the US Federal Reserve. Banxico began cutting rates in March, and some analysts believe there is room for further cuts if growth disappoints.
However, inflation has been on the rise for the past five months, reaching 5.57 per cent in July. The central bank revised its inflation forecast for the fourth quarter to 4.4 per cent, up from 4 per cent.
Gaby Siller, analyst at Banco Base, criticized the decision, stating, “This decision could affect the reputation of the Bank of Mexico… it’s inconsistent.”
The central bank hinted at potential future rate cuts depending on the inflationary environment and the impact of weak economic activity.