Bold Move: Banco de Mexico Reduces Interest Rates

MEXICO - In Brief 06 Sep 2013 by Mauricio Gonzalez

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Banco de México announced an interest rate reduction (domestic interbank rate), of 25 basis points, to an annual 3.75%.The reasoning behind México’s central bank is based on two main factors: i) the fact that consumer inflation has diminished to an annual 3.5%, clearly below the upper bound of the bank’s comfort zone (3%-4%) and ii) stronger economic deceleration, clearly reflected in GDP Q2 annual growth of just 1.5% (as opposed to expectations of 2.5%), which implies no pressure on prices from aggregate demand.Reducing domestic interest rates at this moment is a bold action by Banco de México for at least two reasons: the fact that the Fed is most likely to raise interest rates sooner than later, due to stronger economic recovery in the US and the uncertain final outcome of the discussion of fiscal/energy reforms that may, or may not, strengthen public finance.México’s central bank has showed extraordinary resilience in the past few years to change interest rates in timely fashion. It does so only to validate what money markets dictate, not as an instrument  to influence them. By rowing against the foreseeable path of international rates in the following months, Banco de México creates an additional risk for the foreign exchange market, since the exchange rate absorbs the effects that belong to untimely interest rate changes.Also, by acting without full knowledge how public finance will be affected by fiscal and/or energy reforms, the central bank creates the chance of reversing from dovish to hawkish abruptly.We wonder what was the urgency by  Banco de México to alter interest rates at this moment, considering that by November 15 the basics of fiscal and energy refo...