June 25 (Bloomberg) -- Mexico’s surprise interest-rate cut has traders and banks led by Bank of America Corp. bracing for faster inflation.
Bond investors’ cost-of-living expectations have risen 0.47 percentage point since the central bank cut its benchmark rate to a record 3 percent on June 6, according to data compiled by Bloomberg. That’s more than the 0.26 point increase in Brazil, Latin America’s biggest economy.
Strategists at Bank of America are recommending investors buy Mexican inflation-linked bonds since the rate cut will make it harder for the central bank to bring consumer price increases to its 3 percent target from 3.71 percent in the first half of June. One policy maker who dissented in the 3-2 rate decision, which surprised all 20 analysts surveyed by Bloomberg, warned it could jeopardize the bank’s credibility.
“With the cut, the probability of higher inflation increases,” Carlos Capistran, the chief Mexico economist at Bank of America, said by phone from Mexico City. “It certainly makes the 3 percent inflation target harder to reach.”
Bank of America began recommending buying inflation-linked bonds due in June 2016 in March. The yield on the inflation-linked bonds has dropped 1.19 percentage point from a nine-month high in April to 0.12 percent.
Ricardo Medina Macias, a spokesman for the central bank, didn’t immediately return an e-mail seeking comment.
Banco de Mexico, led by Governor Agustin Carstens, lowered the key rate by a half-percentage point this month in a bid to revive growth in Latin America’s second-biggest economy. Since Carstens took office in January 2010, annual inflation in Mexico has reached the bank’s target in just one month, in March 2011.
The gap between yields on fixed-rate bonds and inflation-linked notes due in December, a measure of investors’ expectations for living costs known as the break-even rate, climbed to 4.36 percent on June 19, the highest level since November 2012.
“It’s going to be complicated for the central bank to reach the inflation target,” Mario Correa, the chief Mexico economist at Bank of Nova Scotia, said by phone from Mexico City. “They don’t have a good track record of doing it.”
A benchmark rate of minus 0.71 percent after inflation will also discourage saving and prompt investors to take on more risk, Correa said. Mexico’s real rate is now the lowest in Latin America, data compiled by Bloomberg show.
“Having a negative interest rate is spurring people to take risks that can generate financial bubbles,” he said.
Marco Oviedo, the chief Mexico economist at Barclays Plc, said the central bank’s rate cut hasn’t put its ability to reach the inflation target at risk because the economy remains weak. The bank lowered borrowing costs two weeks after reducing its 2014 growth forecast.
“It was the last chance the central bank had to implement this cut,” Oviedo said by phone from New York. “I don’t think it’s a problem because the economy seemed to be far away from its potential and was lagging.”
Mexico’s peso rose 0.4 percent to 13.0107 per dollar at 1:27 p.m. in New York.
Analysts polled by Bloomberg estimate consumer prices will rise 4 percent this year, according to the median forecast in a Bloomberg survey. The rate reduction will probably lead to a pickup in inflation because the economy is already beginning to recover, Bank of America’s Capistran said.
“This cut, given the lag with which monetary policy affects the economy, may help the economy when it is already growing,” he said.
To contact the reporter on this story: Eric Martin in Mexico City at email@example.com