By Orbex

Tomorrow we have what could be one of the biggest events for the Mexican peso so far this year. Banxico must decide what to do with the interest rate. Mexico’s central bank is between a rock and a hard place. Inflation is quite high, but the economy is struggling to lift off. In this context, world banks are cutting rates, widening the bond rate differential and making things difficult for Mexican exporters.

What can the Banxico do? There are quite a lot of people who would like to see a rate cut, including the Mexican Government. President López has repeatedly called for a cut to rates, although at the same time insisting on the independence of the central bank. So far, though, the central bank hasn’t agreed.

What Are We Expecting?

The consensus among analysts is that the Banxico will hold rates steady for one more month, but strike as dovish a tone as possible. However, almost everyone still sees a rate cut by September. This means that although they expect the bank to hold fast, a rate cut this time around also would not be a surprise.

This would be the first rate cut since 2014, after a prolonged tightening cycle as the bank fought rising inflation. The arguments for a rate cut are based on keeping pace with the Fed, as well as most major central banks around the world. If the Banxico were to keep rates on hold, it would be relatively equivalent to a rate hike; and have a consequent effect on the peso over the next month. Those analysts also point to moderation in the inflation rate lately, in line with the central bank’s projections earlier in the year.

The Structural Issues

The thing is, though, even with the third highest interest rate in the BIS system at 8.25%, Mexico has been suffering from capital flight. Over $8.5B in capital has left the country in the last six months. Adjusted for inflation, Mexico has the highest interest rate in the (free market) world.

As mentioned previously, many economists believe Mexico’s economic problem is structural, and a change in monetary policy won’t correct the problem. This view is shared by the Banxico. In its last meeting, they blamed a drop in foreign direct investment, reversing capital flows and sluggish growth on institutional and structural problems.

It’s Not Unique

Of course, Mexico isn’t the only country where the central bank warns about structural problems. Eurozone is another example of this. In the end, monetary policy is often trimmed to try to maximize growth regardless of the lack of political will to improve fiscal policy.

Lately, data has suggested that at least domestically, the economy is drifting towards where the central bank is more comfortable. Last week we saw consumer demand was still firmly in growth, and annualized inflation fell below 4.0% for the first time in years. Even the trade balance has been positive for the last few months.

Is it International or Domestic?

Mexico is, of course, subject to the general economic softness in the world’s economy. On top of that, though, is the unpredictable nature of their largest customer. Trump has repeatedly threatened to lay tariffs on Mexico, and the USMCA has still not been ratified by the US Congress. This adds additional uncertainty to an economy already wary of the new president’s policies.

With the peso weakening lately, the Banxico has a balance a lot of moving parts in determining policy. Even if they do cut rates, it might not be seen as enough by the markets to prop up the economy. There seems little they can do that will provide strength to the peso for now.

By Orbex