Thursday, June 4, 2015

Mexico holds rate, reduces inflation expectations

    Mexico's central bank held its benchmark target for the overnight interest rate steady at 3.0 percent, as widely expected, but said expectations for average headline and underlying inflation in 2015 and 2016 had been reduced to below the bank's 3.0 percent target but inflation expectations still remain well anchored despite the depreciation of the peso in previous months.
   The Bank of Mexico, which last cut its rate by 50 basis points in June 2014, said the transfer of a lower peso to inflation had been largely in line with expectations and had mainly showed up in durable goods, with no second-order effects.
    In addition, reductions in the prices of energy and telecommunications has also contributed to low inflation. Slack conditions in the economy will keep inflation below 3 percent for the rest of the year but by 2016 headline and core inflation will be closer to 3 percent.
    Mexico's consumer price inflation rate eased to 3.06 percent in April, slightly down from 3.14 percent in March and up from 3.0 percent in February, and further to 2.93 percent by mid-May. The Bank of Mexico targets inflation of 3.0 percent, plus/minus one percentage point.
    Like many other emerging market currencies, the peso has been depreciating on concern that global investors will suddenly shift their funds out of emerging market assets and into U.S. dollar assets when the Federal Reserve starts tightening.
    In recent weeks, the central bank said the peso had fluctuated in a relatively narrow range against the dollar, but added that it would not rule out that it would become more volatile in coming months due to the uncertain international environment.
     The peso's decline started in May 2014 but the pace of its drop has normally been gradual apart from a brief spurt in December last year, with the value of the peso also being undermined by last year's tumble in crude oil prices.
    This year the peso has continued to depreciate and dropped below 15.5 to the U.S. dollar - lows not seen since March 2009 - in both March and early May and earlier today fell to 15.58 before recovering to trade around 15.50, a drop of just over 5 percent to the U.S. dollar this year today 16.1 percent since the end of 2013.

    Since March the Bank of Mexico has supported the peso in daily auctions under a $3 billion intervention program that is set to expire next week.
    However, policy makers said last month they would continue to sell $52 million a day in the foreign exchange markets at least through Sept. 29 and also sell $220 million - compared with daily turnover of some $57 billion - when the peso drops more than 1.5 percent during a trading session.
    Economic activity in Mexico continues to show moderate growth, the central bank said, with a recovery of investments losing strength while some indicators of consumption appear to be recovering, supported by the labor market and low inflation.
     Mexico's Gross Domestic Product rose by 0.4 percent in first quarter from fourth quarter for annual growth of 2.5 percent, marginally below 2.6 in the fourth quarter.
    Last month the central bank lowered its growth forecast for this year to between 2.0-3.0 percent from 2.5-34.5 percent due to weak export growth to the U.S., a fall in oil output and sluggish consumer demand.
    For 2016 the Bank of Mexico cut its growth forecast to 2.5-3.5 percent from 2.9-3.9 percent.
    Despite the lower growth forecast, Agustin Carstens, the central bank's governor, said on May 19 that this did not mean a cut in interest rates as the more likely scenario was that rates would have to be raised if higher U.S. rates led to a fall in the peso and thus a rise in inflation expectations.


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