Inflation and rates turn on alert of an “economic hurricane” for Mexico

Faced with unstoppable inflation that surprised by reaching 7.88% in the first half of June, Banco de México (Banxico) reacted by making the cost of money more expensive.

The central bank prescribed a dose not seen for 14 years, of 75 basis points, and with it took the reference rate to 7.75%, a level that may further cool the already weakened economy, analysts said.

They established that, if a new shock arises, or that the Federal Reserve (fed) of the United States raises its rate by 100 points, the Government Board would do the same and possibly force Banxico to accelerate the arrival of a double-digit rate.

Read more: Unstoppable inflation: it reaches 7.88% in the first half of June, its highest level in more than 21 years: Inegi

“In Mexico, a space is opening up for a more pronounced slowdown in our economy,” he warned through an analysis by CIAL Dun & Bradstreet. “For now, the market expects the Gross Domestic Product to grow 1.8% in 2022, but it could be revised down if the US Fed intensifies its rate hikes and Banxico does the same, in an attempt to stop the current inflationary spiral” .

The economist for Mexico at BNP Paribas, Pamela Díaz, pointed out that “there is an impact on economic activity from a more restrictive monetary policy.”

“You have to see the transmission channels and to what extent the channel of expectations has a more important weight over that of credit”, he considered.

Díaz highlighted that for consumers the impact depends on the different credit segments, such as mortgages and personal loans, because they are slightly more sensitive to increases in the reference rate. In other items, such as credit cards, the effect is smaller, he noted.

Read more: IMEF expects Banxico to raise rate 75 pts to “attack the great gray bear” that is inflation

In general terms, he explained that the impact on the credit channel in Mexico is limited compared to other countries due to the low levels of financial inclusion and greater competition. The foregoing somehow limits the impact of the fight against inflation on the interest rates of bank loans.

However, on the positive side, it helps to anchor expectations and that prices do not have such great sensitivity, he said.

In order for the monetary policy measures to lead to a recessive terrain, the specialist mentioned a key concept: the ex-ante real neutral rate is located at 2.9%, that is, within the high range that Banxico estimates.

“At the time that Banxico moves above this range for the neutral monetary policy rate, we can speak of an impact on the economy,” he pondered.

double digit rate

Through a report, Banorte analysts considered that Banxico’s reference rate will be at a historical level of 10% at the end of this year.

The bank’s specialists project a new increase of 75 base points next August, as well as another three of 50 base points each in the remainder of the year.

“With this, the reference rate would reach 10.00% at the end of 2022 [previo: 9.50%], which constitutes our new estimate of the terminal rate for this cycle”, they highlighted. However, Vector’s deputy director of analysis, Luis Adrián Muñiz, ruled out an increase of 100 points because, if the pace picks up, the market will ask for more and will incorporate it into the yield curve.

“Banxico will be more careful, because the problem is not to enter, but to leave; a double-digit reference rate is not the scenario with the current inflationary conditions, it is rather a psychological level”. His point of view is that monetary harshness is not indefinite, since an inflation of between 4% and 4.5% in 2023 would not merit a double-digit reference rate.

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