Banxico Expected To Hold Steady

Later today we have one of the more important events on the economic calendar for the Mexican peso: the Bank of Mexico’s interest rate decision.

Just ahead of that we have the trade balance data, which might have a more muted reaction as traders await the more important event later. As usual, when a central bank holds pat, the focus is more on the monetary policy statement that accompanies the decision.

The Banxico has been fighting increasing inflation for quite a long time now. And it has repeatedly expressed concern over the economic effect that the exchange rate would have on the economy. This has led to what some analysts call an “unwarranted hawkish” tone in their communications, especially in the recent months where the economic outlook has been worrisome.

What We Are Looking For

There is an almost unanimous consensus that the bank will hold rates steady at 8.25%. This would be the fifth consecutive hold after a hiking cycle from 3.0% in late 2015. Where there is a certain amount of discrepancy among analysts is regarding how the hawkish the tone of the policy statement and the guidance will be.

Where we could also see some market action is if there is a change in the votes for the rate decision. The last time around, the decision was unanimous. If there is a change in the vote pattern to support a 0.25% cut, then we could see the market react.

The Bank’s Stance

When comparing to the prior monetary statement, the key things that the bank has been focusing on in terms of determining policy are the exchange rate pass-through. That means how the exchange rate is affecting the Mexican economy. The US is Mexico’s largest trade partner, and while a weaker peso helps exports, it increases inflation.

Concerns about inflation are the second aspect that the bank will focus on. Last time around, they said the inflation situation is transitory. If their language changes and sees inflation as more long term, then that would be hawkish and support the peso.

Finally, we have their perception on the balance of risk, which last time, they said had “become more uncertain” and continued to tilt downwards. This is the only part of the statement that is able to offer an opening to express dovishness.

The Fed

The Banxico does take into account the relative policy difference between the US and Mexico since it has implications for the exchange rate and inflation. With analysts penciling in a rate cut by the Fed next month, this would open the possibility that the Bank of Mexico could cut rates to keep pace. Given the drop in economic performance, the bank is under pressure to lower rates. However, it can’t justify doing that given current inflation.

A cut by the Fed would widen the bond yield spread. It would also give Banxico some room to cut rates in a pattern following the Fed. This is the argument offered by the analysts expecting more dovishness and arguing for the beginning of an easing cycle by the end of the year.

The Markets

The USDMXN has remained largely stable since the last meeting, and inflation has slowed a bit (supporting the bank’s argument that the increase was transitory). The peso also gets support from the price of crude, which has increased lately over tensions in the Middle East. With little change in the indicators that the bank follows since the last meeting, there is a good chance of a broad reaffirmation of views.