Mexico Unexpectedly Cuts Rate as Pena Fails to Boost Growth

Mexico’s central bank unexpectedly cut its key interest rate to a record low in an effort to compensate for weak growth in Latin America’s second largest economy. Government bonds rallied.

Banco de Mexico’s board, led by Governor Agustin Carstens, lowered the overnight rate by half a percentage point to 3 percent, surprising all 20 economists surveyed by Bloomberg who had forecast no change. Two weeks earlier, the bank and the Finance Ministry had cut their growth forecasts for this year.

Carstens, who has only reached the 3 percent inflation target in one month since coming to office in January 2010, is adding stimulus to an economy where growth has missed analyst forecasts in seven of the past eight quarters. While President Enrique Pena Nieto has wooed investors with policies such as ending the state monopoly on oil production, consumer confidence has fallen, crimping domestic demand.

“I just said ‘Wow’” when the decision was announced, Alonso Cervera, the chief Latin America economist at Credit Suisse Group AG, said in an emailed response to questions. “I don’t think the first-quarter real GDP number was so bad to justify such an aggressive and unexpected move.”

Mexico’s peso dropped 0.3 percent to 12.8986 per dollar at 12:31 p.m. in Mexico City. The IPC stock index climbed 1.3 percent to 42,727.30, the highest intraday level since January. The yield on Mexico’s fixed-rate government peso bonds due in 2024 fell 0.32 percentage point to 5.64 percent.

Disappointing Growth

As domestic spending and investment remain weak, slack in the economy has increased, the bank said in the statement accompanying today’s report. Inflation doesn’t face pressures from aggregate demand and the odds for inflation reaching the target in early 2015 have risen “significantly,” the bank said.

Additional rate cuts aren’t recommended in the foreseeable future, policy makers said.

Annual inflation slowed to 3.44 percent in the first two weeks of May, the lowest rate since October and down from 3.5 percent in April. Inflation has eased from 4.48 percent in January, when the government increased the sales tax along the U.S. border and in some coastal areas to 16 percent from 11 percent and implemented a new 1-peso-per liter duty on soft drinks.

Faster Inflation

Carstens said on May 21 that inflation may still climb above the 4 percent upper end of the central bank’s target range for some months in the second half before slowing to end 2014 below 4 percent. Today’s decision increases the odds for faster inflation, said Carlos Capistran, the chief Mexico economist at Bank of America Corp.

“The real rate now is negative, which seems too loose given inflation is still above the target,” Capistran said in an e-mailed response to questions.

The central bank reduced its growth forecast for this year on May 21 to between 2.3 percent and 3.3 percent from a previous estimate of 3 percent to 4 percent after the U.S. economy, the biggest buyer of Mexican exports, stalled in the first quarter. Latin America’s largest economy after Brazil expanded last year at the slowest pace since the 2009 recession.

Pena Nieto said Mexico needs to grow faster than the 2.6 percent average of the past two decades and has pushed through a raft of legislation covering everything from taxes on sugary drinks to boosting oil output.

Oil Dependence

While tax increases will cut Mexico’s dependence on oil revenue to as little as 27 percent of the budget by 2018 from 34 percent last year, it has crimped private spending, sending consumer confidence in January to the lowest level in almost four years.

Pena Nieto’s approval rating has dropped to 49 percent from 54 percent when he took office, less than predecessors Vicente Fox and Felipe Calderon at this point in their administrations, according to a survey released last week by Mexico City-based pollster Consulta Mitofsky.

The economy was the biggest concern for 59 percent of participants in the Mitofsky poll, compared with 37 percent who listed security as their top priority.

Miguel Angel Gonzalez, 42, a shoe shiner near the capital’s gold-painted Angel of Independence monument, has seen his weekly earnings fall by as much as half from a few years ago, to 800 pesos ($62) a week, he said.

“Salaries are very low, especially for office workers, and they’re most of my customers,” Gonzalez said. “Some have come around asking me if I know of any work they could do because they lost their jobs.”

Investor Optimism

In contrast to voters, investors have welcomed Pena Nieto’s policies. The cost to protect Mexico’s bonds against default has fallen 0.18 percentage point this year to 0.74 percent yesterday, near the least since May 2008, according to CMA Ltd. data. That’s 0.02 percentage point less than Chile, the smallest premium in at least a decade of data. Mexico is rated BBB+ at Standard & Poor’s, four levels below Chile’s AA- rating.

Pena Nieto’s move to open the oil industry to more private investment prompted Moody’s Investors Service in February to raise Mexico’s credit grade to A3, four levels above junk, saying it will help add about 1 percentage point to the country’s long-term economic growth rate.

The government increased spending by 12 percent in the first four months of 2014 from a year earlier and plans to run a budget deficit of 1.5 percent of gross domestic product for this year, the largest gap since 2010. Economic growth was held back last year by spending delays caused by the transition to a new presidential administration.

The economy expanded 1.8 percent in the first quarter from the year earlier, compared with the median 2.1 percent forecast of analysts surveyed by Bloomberg and up from 1.1 percent in 2013.

“Banxico is providing support to the economy in the context of a shortage of ammunition from other economic policies,” Gabriel Lozano, chief Mexico economist at JPMorgan Chase & Co., said in an e-mailed response to questions. “They know the Ministry of Finance has done what is in its hands and cannot do anything further.”

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