MNI INTERVIEW: Banxico Can Cut More If Fed Turns Dovish-Werner

The Central Bank of Mexico is likely to stick with 25-basis-point rate cuts for now, though it could have more room to ease if the Federal Reserve signals a clear dovish stance over the coming months, potentially strengthening the peso, Banxico’s former director of economic studies Alejandro Werner told MNI.

"If the Fed cuts 25bp today, Banxico might stick with 25bp cuts for a while. However, if the Fed signals a clear dovish stance and the peso appreciates, Banxico could deliver another 50bp cut, especially if the Mexican economy slows toward the end of the year," he said in an interview. "Still, there is a very high chance they will stick with 25bp.”

Banxico’s decision to slow the pace of its easing last month, reducing its overnight interbank rate 25 basis points to 7.75% and signaling more cuts ahead without specifying the size, was a prudent one, said Werner, who also served as director of the Western Hemisphere Department at the International Monetary Fund until 2021 and is now a director of the Georgetown Americas Institute and a non-resident senior fellow at the Peterson Institute for International Economics.

What matters more than the size of the cuts is the signal Banxico gives about the terminal rate, Werner said, adding that the central bank should be clearer about its thinking regarding where it expects the cycle to end.

“Their communication is very minimal. But I think now they should start talking about their terminal rate, and maybe make some assumptions about where the Fed is going to stop. I think that would be important because it could help guide the reaction in the long-term rates that we have been seeing in the 10-year rate,” he said.

“And I think we will start seeing clues of what Banxico's tolerance is for staying at the upper part of the inflation band. They always say that they're doing everything to achieve 3%. But on average, they have never achieved 3%. Maybe there was an 18-month period when they did, but overall their tolerance level has been living above 3%.”

Banxico’s inflation target band is centered at 3% with a 1% margin in either direction. (See MNI INTERVIEW: Banxico To Cut Once More And Hold - Covarrubias)

Werner also noted that the effects of U.S. trade policy on inflation remain uncertain and could be disinflationary, but Mexico’s own tariffs on China could push prices higher.

NEUTRAL LEVEL UNCERTAIN

He also pointed to doubts about the neutral rate. Banxico estimates that it lies a range between 1.8% and 3.6% in real terms, with a midpoint of 2.7%, but the former director believes it could be lower.

"Banxico takes five methodologies to estimate the neutral level and averages them. They should decide on a methodology that actually applies to the Mexican economy and stick with that one," Werner commented.

"Many of the other methodologies they use are designed for a closed economy, and since Mexico borrows from the rest of the world, that tends to push the interest rate higher. Therefore, Banxico tends to be more hawkish than it needs to be. Regarding the terminal rate, I think that would be an interesting discussion, but I haven’t seen it yet.”