Mexico’s central bank is closing in on an inflection point, which might imply a change in policy.
This is why investors are keen to see what happens not just from the rate decision, but most importantly the accompanying statement. The trajectory of interest rates is expected to play a large role in the peso’s evolution over the coming months.
What’s happening is that inflation is starting to move higher as the economy struggles ahead in the aftermath of the second covid wave. Case numbers peaked in late January, but Mexico lacking domestic production of vaccines has struggled to get its population inoculated.
This means that investors don’t have confidence that a third wave might not come along. So, even though there is increasing economic activity, it’s not as fast as might be expected from the case numbers.
Where things are going
This creates a problem as authorities still need to keep supporting the economy with extremely accommodative policy.
But that, combined with increased economic activity, leads to higher inflation. The lack of monetary stability could, then, also impact the prospect of economic growth as investors weigh the future situation for the country.
Last week, Mexico reported an April CPI of 6.1%. This was the fastest increase since 2017, when Banxico embarked on its aggressive move to get the currency under control.
In fact, at the prior meeting, the central bank also raised their forecasts for inflation, acknowledging it will be above their target range for the rest of the year.
How much leeway?
Like most other central banks trying to prop up the economy as it reopens post-pandemic, Banxico argues that the current spike in inflation will be transitory.
Coupled with the lack of inflation during the pandemic period, it would balance out in the medium term. So, policy doesn’t need to be amended to deal with a “short-term” move in inflation.
The consensus among analysts is that Banxico will take a wait-and-see approach for at least one more month, and keep policy steady. So attention turns to see if they will provide any hints about when the next rate hike will be.
Naturally, this won’t be explicit. So, we will likely understand it through any potential change in the bank’s outlook.
What to look out for
The latest survey of economists expects inflation to be at 4.7% by the end of the year. Remember that the Banxico targets between 2-4%.
This isn’t all that different from the latest projections from the central bank at their last meeting for 4.6%.
If Banxico keeps its expectations for inflation the same, the market might take it as an indication that a rate hike is still pretty far off. Therefore, this will weaken the peso a bit.
On the other hand, traders could see a further rise in the expectations of inflation (say, at or near 5.0%) as a clear sign they are getting ready to raise rates in the next couple of months. Therefore, this would push the peso higher.