Background on Key Players and Their Influence
On December 10, the Federal Open Market Committee (FOMC) of the Federal Reserve (Fed) voted, by a majority, to reduce the federal funds rate by 25 basis points, placing it in a range of 3.50%-3.75%. Three dissenting votes were cast: Austan D. Goolsbee and Jeffrey R. Schmid voted to keep the range unchanged, while Stephen I. Miran advocated for a 50 basis point reduction, placing the rate in a range of 3.25%-3.50%. Understanding these central banks’ roles is crucial, as their decisions significantly impact global financial markets.
Inflation Context and Central Bank Projections
In November, general inflation measured by the Consumer Price Index (CPI) stood at 2.7%, while the underlying component was 2.6%. However, the Personal Consumption Expenditures (PCE) index showed 2.8% inflation in September, with an underlying component of 2.8%. Both inflation indicators had been rising since May but now appear to be moderating. The Fed projects reaching the 2% inflation target, as measured by the PCE, by 2028.
Real Neutral Rate and Current Interest Rate Levels
Assuming the real neutral rate currently oscillates between 0.8% and 1.4%, the current reference rate levels, combined with the Fed’s inflation projections for the upcoming year, imply an ex-ante real rate between 1.1% and 1.35%. This places the ex-ante real rate in line with the real neutral rate.
Banxico’s Decision and Inflation Outlook
The Board of Governors at Banxico decided, by a majority of 4 out of 5 votes, to lower the target interest rate for the Interbank Lending Rate by 25 basis points, setting it at 7.0%. This places the reference rate still in restrictive territory (according to Banxico’s projections), though nearing a more neutral level. The real neutral rate is estimated by Banxico at 2.7% ±0.9%, with a nominal rate of 5.7% ±0.9%, assuming inflation converges to 3%. During the second half of November, general inflation was at 3.99%, while November’s inflation was 3.80%. Banxico estimates reaching the 3% inflation target by the third quarter of 2026, a projection it has reaffirmed throughout the year.
Comparison of Real Rates and Implications
According to the Fed’s estimates, the ex-ante real rate is between 1.1% and 1.35%, while Banxico’s is at 4.0%. Previously, the Fed’s ex-ante real rate was between 1.15% and 1.4%, and Banxico’s was at 4.25%. The expected real rate differential has decreased from 2.85%-3.1% to 2.65%-2.9%, a reduction of 20 basis points.
Potential Impact on Mexican Peso
This decrease in the real rate differential could imply less support for the exchange rate from interest rate differentials, which, combined with lower remittances, might weaken the Mexican peso. However, the broad dollar weakness due to other factors could maintain the peso’s strength in the coming months. It is essential to remember that inflation trajectories may differ significantly from those projected by both central banks.
