Mexican Peso stays strong with little prospect of official rate cuts

Kathryn Rooney Vera, Chief Market Strategist at StoneX, recently spoke with Irene Espinosa, deputy governor of the Mexican central bank, Banxico, about the outlook for the Mexican economy – and the potential impact on the Mexican Peso The key takeaway was that a strong economy makes rate cuts a distant possibility. Official interest rates have been at 11.25% since March. Consequently, the Mexican peso remains one of the strongest emerging market currencies, up 15% against the dollar in the past twelve months.  

“Banxico has hiked rates by more than 700 basis points without a meaningful impact on economic activity, the labor market, or inflation due to weak transmission channels in Mexico,” Ms. Rooney Vera observes. “While inflation remains above target, it is our view that Banxico will hold rates and continue to focus on their price stability mandate.”

Mexican Official Interest Rate

Source: StoneX

Amongst factors contributing to this restrictive view of monetary policy, according to Ms. Rooney Vera, are:

• Above trend growth and growth forecasts adjusted to the upside mean upside pressure on inflation, which is not yet at target with core inflation driven by services. 
• Mexico’s economy has been remarkably resilient, and the output gap is closed and positive, with some signs of overheating and a tight labor market. 
• Fiscal policy is expected to be stimulative next year 
• Inflation is running above target with the balance of risks biased to the upside for inflation 
• Easing prematurely would have more costs than benefits; vigilance required

Above trend growth and a loose fiscal policy have meant that Mexico’s monetary authority has had to continuously adjust their growth forecasts to the upside. The economy’s output gap has closed and has been in positive territory for several months now, putting upward pressure on inflation. The Mexican economy is tight at the same time pro cyclical fiscal policy is in the pipeline for the next year. 

USD / Mexican Peso

Source: TradingView

Other inflation drivers are evident, to Ms. Rooney Vera observes. The labor market in Mexico is very tight, with wages increasing at historic rates and the unemployment rate below 3%. Core inflation remains sticky and driven mainly by services. All signs point to a very tight economy with some symptoms of overheating and additional ongoing price pressures. 

Banxico has built its monetary policy credibility and will only let up once the economy cools. The risk of prematurely loosening monetary policy could bring more costs than benefits. “Banxico has hiked rates by more than 700 basis points without a meaningful impact on economic activity, the labor market, or inflation due to weak transmission channels in Mexico,” Ms. Rooney Vera comments. “While inflation remains above target, it is our view that Banxico will hold rates, and continue to focus on their price stability mandate.”

Next year, Mexico has major congressional and presidential elections, but no significant policy shift is anticipated from either leading candidate, Claudia Sheinbaum, or Senator Xóchitl Gálvez. Both appear intent to capitalize on the economic opportunities inherent in the “nearshoring” phenomenon. Mexico is now the leading trade partner of the US rather than China, with the reconfiguration of supply chains bringing business from Chinese companies to Mexico. This phenomenon promises long-term economic benefits and strong growth for Mexico.

Kathryn Rooney Vera is Chief Market Strategist at StoneX: kathryn.rooneyvera@stonex.com