Policy rates and politics to support Mexico's currency rebound

Summary

Mexico's central bank restarted its easing cycle last week and signaled a tentative preference to ease monetary policy further going forward. Policymakers seemed focused on slowing growth and core inflation rather than currency volatility, and as a result, we have adjusted our Banxico policy rate forecast lower. With the direction of monetary policy clearer, financial markets are now likely to be focused on politics. Debates around constitutional amendments and fiscal policy will come to the forefront in Mexico in the coming weeks, while the U.S. presidential election is around the corner. Political developments are key risks to our constructive long-term Mexican peso outlook; however, we remain optimistic that worst case scenarios will be avoided and continue to believe the Mexican peso can recover over the long-term.

Policymakers pave the way for easier policy

Banxico's latest rate decision was always going to be a close call. Markets and economists alike were split on whether policymakers would keep rates unchanged or resume the easing cycle. In a 3-2 split vote, policymakers opted to restart the rate cutting cycle by delivering 25 bps of easing, lowering the overnight rate to 10.75%. The official statement highlighted that policymakers are most concerned with slowing economic prospects. Indeed, Mexico's economy has demonstrated signs of deceleration over the course of this year, which, combined with a slowing U.S. economy, means growth prospects in Mexico are under a bit of pressure. Also, policymakers revealed that while headline inflation risks are still tilted to the upside, core inflation is tame and contained enough to warrant easier monetary policy. In a mild surprise, at least to us, Banxico barely mentioned Mexican peso depreciation and volatility nor did voting members indicate any form of concern related to political risks either domestic or external. We interpret Banxico forward guidance to mean additional rate cuts are on the way; however, we got the impression that policymakers will still approach monetary policy decisions with a degree of caution. In that sense, despite our base case being that the Federal Reserve delivers back-to-back 50 bps rate cuts starting in September, we believe Mexico's central bank, at least for the time being, will lower interest rates by 25 bps at each meeting through the end of this year. Our revised Banxico outlook now means we forecast Mexico's policy rate to fall to 10.00% by the end of this year. We also believe policymakers will ease monetary policy further in 2025, and now forecast a year-end 2025 policy rate of 8.00%. As far as risks to our Banxico forecast, risks are tilted toward more aggressive easing, especially if the Fed does indeed deliver the 50 bps cuts we forecast or Mexico's economy decelerates more quickly than we expect.

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