MNI INTERVIEW: Banxico Cuts Hinge On Iran Outlook -Covarrubias

The Central Bank of Mexico could have delivered its last 25-basis-point cut of the cycle last week, as the potential for any further easing will be data-dependent and closely tied to the duration and magnitude of the war in Iran, former Banxico deputy manager of research strategy Enrique Covarrubias told MNI.

"Although observed inflation is elevated, it is not yet driven by oil, but rather reflects a one-off shock in non-core inflation, alongside significant economic weakness and prior communication from the Central Bank of Mexico that a rate cut at last meeting was already planned," Covarrubias, now chief economist at Actinver, said in an interview.

"In this context, the signal the market took was that this could be the final cut, with any subsequent moves becoming data-dependent and, above all, contingent on the duration and magnitude of the war in Iran.”

The discussion now is more about whether there will be room to cut rates between now and mid-year, he noted. "The Central Bank of Mexico is trying to make the market understand that further cuts are not guaranteed and will depend largely on how this context feeds through to inflation."

END OF EASING CYCLE

Covarrubias noted that before the conflict in Iran the central bank had already been signaling that the end of the cycle was near, with the market estimating the terminal rate at around 6.5%. (See MNI BANXICO WATCH: Dovish Decision Amid War Spurs Board Split)

The recent decision to cut was based on three factors, according to the former Banxico manager: signaling that the cycle is nearing its end, acknowledging economic weakness -- particularly in industry --, and an assessment that the recent rise in inflation was temporary, driven by food prices, with no direct impact from oil yet.

Fuel prices in Mexico are not as closely linked to international prices as in other economies, he noted.

Banxico decided to cut its interest rate by 25 basis points to 6.75% last week, with deputy governors Jonathan Heath and Galia Borja dissenting in favor of holding borrowing costs unchanged.

HEALTHY SPLIT

"It seems to me that this is a healthy division. It is a governing board that, among other things, reflects a diversity of views that is relevant in this context," Covarrubias said.

Heath’s dissenting vote is not new, he noted. "He has taken several decisions already reflecting concern about the inflationary environment. Deputy Governor Borja has been in a more middle-ground position, showing somewhat greater concern about inflation than the rest of the board."

Another key aspect to monitor is the exchange rate, he said. "It has been volatile, but within a relatively contained range between 17 and 18 pesos. In the context of the Central Bank of Mexico, while volatility is elevated, it is not yet a concern."

Levels around 18 to the dollar, or even up to MXN 18.50 do not appear particularly concerning for the board, at least for now, Covarrubias said. "However, if we see a deterioration in the exchange rate, that will also be a factor all five members will take into account."