Mexico Unexpectedly Cuts Key Rate for Second Time This Year

Mexican policy makers surprised analysts by cutting their benchmark interest rate for the second time this year, saying the economy experienced a significant and unexpected slowdown in the second quarter.

Banco de Mexico reduced the overnight lending rate by 25 basis points to a record-low 3.75 percent, surprising all but one of the 20 analysts surveyed by Bloomberg who had forecast policy makers would keep the rate on hold.

The central bank, led by Governor Agustin Carstens, cut its growth forecast last month, projecting the economy will expand as little as 2 percent this year, half the pace of 2012 and the least in four years, amid stagnant exports to the U.S. and a first-half drop in government spending. The annual inflation rate fell in each of the past three months amid easing farm price pressures, dropping in July to within the target range for the first time since February.

“This is probably the beginning of an easing cycle,” Italo Lombardi, an economist at Standard Chartered Plc, said in a phone interview from New York. “They’ve been very dovish on inflation already and now they’re using the fact of the economy weakening to amplify that dovishness.”

The central bank said in a statement accompanying its decision that economic risks have intensified and growth next year will probably be below its forecast from the quarterly inflation report on Aug. 7. In that report, Banxico projected growth would be 3.2 percent to 4.2 percent next year.

Policy makers said idle capacity in the economy may persist for a long time.

The Weakening

“The weakening of Mexico’s economic activity intensified significantly during the second quarter,” the bank said in the statement. “This weakening occurred faster and deeper than anticipated.”

The peso gained 1.6 percent to 13.1844 per U.S. dollar at 10:42 a.m. in Mexico City. The increase came after payrolls in the U.S. climbed less than projected, reducing concern the U.S. Federal Reserve will pare back asset purchases this month.

Yields on peso-denominated government bonds maturing in June 2015 fell 20 basis points, or 0.20 percentage point, to 3.99 percent, according to data compiled by Bloomberg. Mexico’s benchmark IPC stock index of 35 Mexican companies rose 1.1 percent after falling as much as 0.3 percent today before the decision.

While the rate cut contrasts with Brazil, Latin America’s biggest economy, which raised rates last week by a half-point to 9 percent, Mexico isn’t the only nation in Latin America to reduce borrowing costs. Colombia, the only major economy in the region with a lower key rate, cut to 3.25 percent in March.

Fed Rate

The Fed has kept the main interest rate near zero since December 2008 and pledged to leave it there as long as the jobless rate remains above 6.5 percent and the outlook for inflation over one to two years doesn’t exceed 2.5 percent. The peso may weaken further and contribute more to inflation if the Fed starts tapering its $85 billion of monthly asset purchases, Mexican policy makers said today.

The currency has tumbled 7.6 percent against the dollar since May 22, when Federal Reserve Chairman Ben S. Bernanke testified to Congress that the Fed “could take a step down” in its bond purchases.

Still, Banxico said it expects a low pass-through to consumer prices from the exchange rate, and that the risks for inflation in the time horizon in which monetary policy can be effective have diminished.

‘Eye Opener’

“This rate cut was an eye opener to those who thought that the central bank was too fixated on the peso and on the Fed,” Alonso Cervera, chief Mexico economist at Credit Suisse Group AG and the only economist in Bloomberg’s survey to forecast a rate reduction, said in an e-mail. “Its success in controlling inflation allows it to move if the economy needs it.”

The inflation rate in July fell to 3.47 percent, and core prices, which exclude more volatile energy and farm costs, grew at a record-low pace of 2.5 percent.

Banxico surprised analysts on March 9 by cutting its key borrowing rate by 0.5 percentage point, the first adjustment since July 2009.

At the Fed’s annual policy symposium in Jackson Hole, Wyoming two weeks ago, Carstens called on its policy makers to clarify their tapering plans, saying developing nations face their “most pressing challenge” from advanced economies exiting stimulus. International Monetary Fund Managing Director Christine Lagarde, in a speech at the same conference, urged policy makers to cooperate more in planning the withdrawal of stimulus.

Coordination Desirable

“It would be desirable to have monetary policy coordination,” Carstens said. “To have the central banks of advanced economies go in different directions, can become a source of instability.”

Fed officials rebuffed those calls, with James Bullard, president of the St. Louis Fed, saying in an interview with Bloomberg Radio that the domestic economy is the primary objective of policy.

Traders in Mexico’s swap-rates market yesterday assigned a 28 percent chance of a cut in borrowing costs over the next six months, down from 72 percent in May. Just three of 24 economists in a survey released yesterday by Citigroup Inc.’s Banamex unit predicted the central bank would cut rates before year end, with the rest projecting policy makers would stay on hold.

Today’s rate cut will help speed up growth in the second half of the year, Finance Minister Luis Videgaray wrote on his Twitter account.

‘Completely Supports’

The ministry “completely supports” the central bank’s decision to cut rates, Videgaray wrote.

Banxico will probably base its decision about whether to cut borrowing costs further on when the Fed decides to taper stimulus and on the level of the peso, said Benito Berber, a strategist at Nomura Holdings Inc. A cut would be less likely should the currency fall to weaker than 14 per U.S. dollar, he said.

“There’s a possibility” that the cut is the start of a cycle of monetary policy easing, Berber said in a phone interview from New York. “A delay on tapering will naturally trigger another 25 basis point cut.”

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