Wednesday, June 19, 2024

Bank cuts benchmark interest rate; weaker peso predicted to follow further cuts

The central bank cut its benchmark interest rate on Thursday in a move that was predicted by economists, who expect the bank to continue monetary policy easing in 2020.

Leading economists forecast a weaker Mexican peso as a result.

The Bank of México cut the interest rate by 25 basis points to 7.5%.

Seventeen of 26 economists surveyed by Bloomberg predicted that the bank would cut its benchmark rate by 0.25% to 7.5% at today’s meeting. The other nine anticipated a 0.5% cut to 7.25%.

The bank made quarter-point cuts at its last two meetings after inflation dropped and the economy continued to slow.

Further rate cuts could diminish the appeal of the peso because they put a dent in its carry trade appeal. Carry trade is a strategy in which investors borrow currency in markets where interest rates are low and buy in markets where they are higher.

The strong performance of the peso since President López Obrador took office is mainly due to demand for the currency generated by its carry trade appeal, Bloomberg said.

Among the world’s major economies, only Argentina, where the economy is in crisis, and Turkey currently have a higher real interest rate (the difference between the interest rate and the inflation rate) than Mexico. A decrease in inflation to the central bank’s target of 3% has left Mexico’s real rate at 4.73%.

If the Bank of México benchmark interest rate continues to fall as predicted, Mexico’s real interest rate will also fall and purchasing pesos will become less attractive to investors, causing the currency to weaken.

“We believe the peso will depreciate gradually for the rest of the year and into 2020 as the carry advantage of the peso erodes,” said Banorte economist Juan Carlos Alderete.

He predicted a 6% interest rate at the end of next year and an exchange rate of 21.3 pesos to the US dollar.

The most recent survey by Citibanamex showed economists predicting on average a 6.5% rate at the end of 2020 and an exchange rate of 20.07 to the dollar. Early on Thursday, the peso weakened 0.55% to 19.46.

Bloomberg said the “debate among economists and strategists isn’t whether the peso will depreciate, but how weak it will become.”

While López Obrador has lauded the strength of the peso since he took office, a weakening of the currency due to monetary policy easing could actually help his government grow the economy because it would make Mexican exports more competitive.

Any economic expansion would be welcome news for the government after growth of just 0.1% in the third quarter, 0.0% in the second and a contraction of 0.3% in the first.

The ailing economy coupled with concern about the government’s policy agenda is affecting investor confidence in Mexico.

The Bank of America Merrill Lynch November survey showed that 77% of investment fund managers in Latin America believe that Mexico will lose its investment grade credit rating.

The figure is the highest since January when the survey first asked fund managers to offer an opinion about the outlook for Mexico’s sovereign rating.

Almost six in 10 fund managers said that government decisions represented a risk to the economy, while 23% expressed concern about the impact on Mexico of a slowdown in the United States.

The possibility of new U.S. tariffs on exports, another cut to Pemex’s credit rating and non-ratification of the new North American trade deal were also cited as risks albeit by just 8%, 4% and 4% of those polled, respectively.

Carlos Capistrán, the Bank of America’s chief economist in Mexico, told the newspaper El Financiero that data shows that investment has dropped significantly in real terms in 2019. Policy “uncertainty is one of the main factors” that has caused investment to fall, he said.

Capistrán said that monetary policy easing could stimulate the economy but predicted that it wouldn’t lift GDP growth above 1% next year.

The Bank of America is forecasting 0.0% growth this year and 0.9% in 2020.

Source: Bloomberg (en), El Financiero (sp) 

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