Background on the Federal Reserve and Its Impact on Mexico
The Federal Reserve (Fed), the central banking system of the United States, is anticipated to reduce its benchmark interest rate by 25 basis points in its upcoming decision scheduled for the following week. This expectation stems from analysts at Pantheon Macroeconomics and Goldman Sachs.
Mexico’s Central Bank and Its Relevance
The Banco de México (Banxico), Mexico’s central bank, has a narrow margin to maintain its restrictive policy. However, it could apply one or two additional cuts in the interest rate, according to analysts from Pantheon Macroeconomics and Goldman Sachs.
Interest Rate Differential Between the US and Mexico
The US interest rate is crucial for Mexico due to the interest rate differential, which acts as an incentive for investors to stay in the market during uncertain times. Currently, this differential stands at 325 basis points, resulting from the difference between Mexico’s nominal rate (7.75%) and the US rate (between 4.25% and 4.50%).
Historically, before the pandemic, Mexico’s interest rate differential was 400 basis points. The current incentive is below this historical level, as noted by Goldman Sachs’ Latin America economist.
Persistent Inflation and Banxico’s Cautious Approach
From London, Andrés Abadía, Chief Economist for Latin America at Pantheon Macroeconomics, pointed out that underlying inflation remains rigid, particularly in the services sub-index.
Underlying inflation is the purest indicator of inflation, excluding volatile prices due to seasonality or administrative decisions. The underlying prices index remains elevated, still above 4%, with consistent stability despite decreasing supply-side pressures, Abadía explained.
According to INEGI data, Mexico’s underlying inflation has fluctuated above 4% in the first eight months of the year and remained steady at 4.44% in July and August.
Goldman Sachs’ economist stated that this “sticky” underlying inflation compels Banxico to aim for inflation convergence towards the 3% target while requiring more cautious calibration of monetary policy.
Negative Output Gap and Continued Monetary Policy Normalization
Goldman Sachs’ expert mentioned that the negative output gap and gloomy growth prospects do not hinder the continuation of the monetary policy normalization cycle.
Meanwhile, Pantheon Macroeconomics’ economist described Mexico’s economic situation as complex yet positive, marked by a cautious recovery and persistent inflationary pressures.
Key Questions and Answers
- Q: What is the expected rate cut by the Federal Reserve? A: The Fed is expected to cut its benchmark interest rate by 25 basis points.
- Q: How does the US interest rate impact Mexico? A: The US interest rate influences Mexico through the interest rate differential, which acts as an incentive for investors to stay in the market during uncertain times.
- Q: What is the current interest rate differential between the US and Mexico? A: The current differential is 325 basis points, with the US rate between 4.25% and 4.50%, and Mexico’s nominal rate at 7.75%.
- Q: Why is underlying inflation significant for Banxico’s decisions? A: Persistent underlying inflation, above 4%, compels Banxico to aim for inflation convergence towards the 3% target while requiring cautious monetary policy calibration.
- Q: How do negative output gap and gloomy growth prospects affect monetary policy? A: Despite these factors, the monetary policy normalization cycle is expected to continue.
