One more and done for Banxico?

Summary

Banxico's August meeting was rather uneventful as most actions taken by Mexico's central bank were largely anticipated. Local economic and market trends suggest Banxico has space for additional easing in September, policy space that is also supported by a Federal Reserve that is likely to lower interest rates next month. With that said, we believe Banxico's easing cycle will end after the September meeting. Core inflation is stubbornly elevated, while the Banxico-Fed rate spread is historically narrow and is a source of high vulnerability to sudden shifts in capital flows to emerging markets. A less dovish outlook for Banxico combined with Mexico being uniquely isolated from expected rises in regional political risk supports our view for near-term Mexican peso strength and longer-term resilience.

Don't expect much more Banxico easing past September

An anticipated policy rate decision in Mexico turned out to be rather uneventful. As expected, Banxico lowered its policy rate by 25 bps to 7.75% at its August meeting. Policymakers continued to demonstrate a modest divergence in views as the decision was split 4-1 with the dissenter in favor of keeping rates unchanged, also as expected. The anticipation associated with the meeting stemmed from the forward guidance that policymakers might offer. Leading into the meeting we believed policymakers would look to give themselves maximum flexibility for future monetary policy decisions. With that said, we were curious if policymakers would commit to further rate cuts or signal a possible end to easing. In line with our view, Banxico's official statement offered little in terms of forward guidance and closely resembled "data dependence" without explicitly using those words. By expressing data dependence, Banxico indeed gives itself room to assess not only the evolution of incoming domestic data, but also external developments, most importantly the Federal Reserve. On the domestic data front, core inflation remains stubbornly high and above the upper bound of Banxico's 3% +/- 1% CPI target. At the same time, an output gap remains in place due to subdued local economic trends, while the peso remains one of the best performing emerging market currencies this year. Externally, soft U.S. labor market data and sluggish U.S. economic trends have led financial markets to price a high likelihood of a Fed rate cut in September. Banxico, historically correlated to Fed monetary policy decisions, will have the luxury of watching what the FOMC does in September before making its own rate decision. As of now, we believe the Fed will deliver a 25 bps cut in September. Fed easing, along with still modest policy space for easing from domestic economic and markets trends, should lead to Banxico delivering another 25 bps rate cut in September.

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