MNI INTERVIEW: Banxico End Signal Doesn't Prevent More Cuts

The Central Bank of Mexico signaling the end of its easing cycle does not rule out the possibility of further rate cuts later on, former Banxico Deputy Governor Manuel Sanchez told MNI, adding that the latest 25-basis-point rate cut to 6.50% was based on weak foundations.

"Like the March decision, the May move was based on weak foundations: elevated inflation, upward revisions to inflation forecasts, a balance of risks tilted to the upside, an unsubstantiated claim of no demand-side pressures and an interest rate within the neutral range, which sends a signal contrary to the commitment to stability," Sanchez, now an economic advisor at Spruceview, said in an interview.

He noted that the board described the first rate cut in 2024 as “not necessarily” the beginning of a cycle and could do the same again in the future. (See MNI INTERVIEW: Post-Election BanRep Hike A Possibility-Steiner)

"The warning in the May statement that the cut concluded 'the cycle initiated in March 2024' does not prevent a new easing cycle from beginning later on, even if they initially argue that such a cut 'does not necessarily imply the beginning of a cycle,' as occurred in March 2024."

NO SIGN OF RATE HIKES

On the other hand, he said that with inflation still well above target, it is not evident that the board would be forced to raise interest rates by the end of the year.

"The inflation target has functioned more as a rhetorical reference than as an effective guide within the separate objective of cutting rates," he pointed out.

The former official stressed that Banxico created a misperception regarding the 3% inflation target when it added a one-percentage-point variability interval in 2002, leading analysts to question whether remaining within that range would be sufficient for the board.

"The central bank has shown no interest in correcting this misperception and, as a result, even experts frequently refer to the target range," he said.

LOOSE INFLATION ANCHOR

Sanchez noted that not even a 4% inflation target appears to be credible.

"Since 2017, inflation seems to have entered a higher-inflation regime, averaging above 5.0%, compared with below 4.0% during the previous ten years. In practice, the board appears comfortable with inflation at 5.0%."

One indication that the board is not targeting 4% inflation is that it has cut rates by 50 basis points this year despite inflation being well above that upper bound, he said.

Recently, the market’s long-term inflation expectations have been more pessimistic than those of the central bank. The discrepancy between Banxico’s forecasts and analysts’ expectations does not mean the latter are better at predicting inflation, Sanchez emphasized.

"It simply means they do not believe Banxico, particularly regarding the claim that inflation will permanently converge to target in the second quarter of 2027."

"Because analysts are more focused on forecasting inflation than on evaluating monetary policy, they know Banxico may postpone that date for the umpteenth time, which also seems to be why they are not overly concerned about it," he added.