Mexico Unexpectedly Cuts Rate in Bid to Overcome Mediocre Growth

Mexico’s unexpected interest rate cut yesterday is a calculated risk to recover from the slowest growth in four years without losing control over inflation.

Mexico’s central bank, led by Governor Agustin Carstens, reduced the overnight rate by half a percentage point to a record-low 3 percent yesterday, surprising all 20 economists surveyed by Bloomberg, who had forecast no change. Domestic demand and investments have failed to recover, holding back the Mexican economy even as exports rebound, the central bank said in announcing its decision.

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 and inflation remains above target. Policies implemented by President Enrique Pena Nieto to lure foreign investors have failed to boost economic growth as the government cut spending and raised taxes.

The central bank’s move was the “right decision, but poorly communicated,” Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc., said in an e-mailed response to questions. “Prolonged mediocre growth is tapering the enthusiasm.”

Inflation Outlook

Inflation doesn’t face pressures from aggregate demand and the odds for inflation nearing the target in early 2015 have risen “significantly,” the bank said. Additional rate cuts aren’t recommended in the foreseeable future given Mexico’s position relative to monetary policy in the U.S., Mexico’s largest trade partner, policy makers said.

Mexico’s peso dropped 0.5 percent to 12.9292 per dollar yesterday. The IPC stock index climbed 1.4 percent to 42,778.26, the highest closing level since December. The yield on Mexico’s fixed-rate government peso bonds due in 2024 fell 0.34 percentage point, the most since 2008, to 5.62 percent.

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.

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. Yesterday’s rate cut increases the odds inflation will reach that level, said Carlos Capistran, the chief Mexico economist at Bank of America Corp.

Real Rate

“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.

Banco de Mexico may have trouble meeting its inflation target in the future after reducing rates at a time when the pace of consumer price increases is above the board’s goal and expected to pick up further, said Mario Correa, chief Mexico economist at Bank of Nova Scotia. Investors may start to doubt the bank’s commitment to slowing inflation to the 3 percent target, he said.

The annual inflation rate has averaged 3.9 percent since the central bank’s first interest-rate cut under Carstens in March 2013. The lowest it’s reached since then on a monthly basis was 3.36 percent in October. Three of the four cuts weren’t predicted by the median projection of analysts in Bloomberg surveys. Banxico has lowered the key rate 1.5 percentage point in the past 15 months after standing pat for more than three years previously, the longest for any Group of 20 nation.

Inflation Target

“Inflation is above the target, and the bank has only met that goal in two or three months since 2005,” Correa, who expects annual inflation to end the year at 4.2 percent, said in a phone interview from Mexico City. “It’s really hard for me to think that by January 2015 we’ll see inflation reaching the 3 percent goal.”

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 economy in the U.S., the biggest buyer of Mexican exports, shrank in the first quarter. Latin America’s largest economy after Brazil expanded last year at the slowest pace since the 2009 recession.

Pena Nieto says 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 0.24 percentage point this year to 0.68 percent yesterday, the least since 2007, according to CMA Ltd. data. That’s 0.01 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.

Government Spending

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.

For Carlos Perez, 26, a roving peddler of tamales, pastries and a corn-based beverage called atole, the economic weakness has cut sales by about half since 2012, to 1,200 pesos ($92.81) a day.

“It’s sad,” he said in an interview on a side street off Paseo de la Reforma, Mexico City’s main business boulevard. “I don’t see things getting better soon.”

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