Mexico Central Bank Cuts GDP Forecast, Highlights Fed Risks

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Mexico’s central bank lowered its 2015 growth forecast, citing a decline in oil production, while saying it may still need to raise interest rates to preserve financial stability.

Gross domestic product will expand 1.7 percent to 2.5 percent this year, down from the previous estimate of 2 percent to 3 percent, and inflation will remain below the 3 percent goal, the central bank said in its quarterly report Wednesday. Governor Agustin Carstens said that although domestic factors point to leaving rates on hold, decisions will depend on how markets and the peso, already trading near record a low, react to an imminent increase by the Federal Reserve.

Mexican policy makers have left the overnight borrowing rate unchanged at a record-low 3 percent since mid-2014 to boost an economy that grew less than analysts expected in eight of the past 12 quarters. More recently, the bank has signaled that higher borrowing costs in the U.S. will probably call for an increase in Mexico, even as the inflation rate falls to the lowest in more than four decades.

“For Mexico’s financial stability, the relative monetary posture between Mexico and the U.S. is very important,” Carstens said in presenting the inflation report.

Delicate Balance

Carstens said policy makers are balancing weak growth and low inflation against the probable Fed move and falling oil prices, which could further weaken the peso and therefore spur inflation. He reiterated Mexico could act before the U.S. if peso volatility gets out of control. Inflation will remain below 3 percent this year and near that level in 2016, the central bank said in the report.

Markets showed muted reaction given that much of Carstens’s message repeated themes he has been sounding in recent weeks. The currency gained 0.2 percent to 16.2775 per U.S. dollar.

While raising interest rates could have a negative impact on growth, inflation is so low in part because the economy continues to grow at less than its full potential, Carstens said. Prices rose 2.74 percent in July from a year earlier, the lowest annual inflation rate since 1968.

Policy makers probably will raise the benchmark overnight rate this quarter for the first time since 2008 as the Federal Reserve increases U.S. borrowing costs, according to the median forecasts in Bloomberg surveys. Mexico’s central bank is concerned a smaller rate advantage versus the U.S. could prompt investors to pull money out of Latin America’s second-largest economy.