Mexico's central bankers split on rate cut signal

Mexico's central bankers split over whether to send a signal to markets that an interest rate cut is possible in future, the minutes of their August meeting showed. All five members of the bank's board agreed that future conditions might make it necessary to cut its benchmark rate from the current 4.5 percent, but there was debate about whether to be open with financial markets and investors.
The minutes showed one board member argued against sending a signal on rate cuts because inflation was still above the central bank's 3 percent annual target, and at least one more agreed that flagging the chance of easier policy would be premature.
"In response to the above arguments, another board member stated that inaction could also mean a great cost," the minutes of the late August meeting said. Mexico's recovery from a punishing recession is stumbling amid weakness in the United States, its main trading partner, while inflation slowed sharply in August, bolstering bets that credit costs could be lowered given the central bank's mandate for low inflation to aid sustainable growth and job creation.
Analysts said the division about signalling potential easing was a telling gauge for the balance of hawks and doves on the board. August's meeting was the first attended by new policymaker Manuel Ramos.
"This tells you there were three that supported it and two who were probably against it," said Alonso Cervera, a economist at Credit Suisse, in a telephone interview from New York. In its post-meeting policy statement on August 26, the central bank said it would consider cutting rates "if the performance of the national economy and international financial markets results in an unnecessary tightening of monetary policy."
The shift in tone took investors by surprise and pushed markets to price in a 25-basis-point in January 2012; previously, investors had seen rates unchanged until at least May 2013. Two weeks later, investors now assign an 80 percent probability of a cut as early as October. All members of the board agreed the balance of risks to inflation had improved, while downside risks to growth had increased.
The minutes showed some policymakers were concerned that an interest rate gap with the United States could hurt the domestic economy. If the Federal Reserve eases policy further, this could attract more capital to Mexico to take advantage of a relatively higher yields, pushing up the peso and potentially hurting demand for exports even while growth is slowing. "If the US does something to stimulate the economy, then Banxico may have to follow," Cervera said.
The Fed's overnight benchmark interest rate has been set at between zero to 0.25 percent since late 2008, while the Mexican central bank's equivalent rate has been at 4.5 percent since July 2009. Short-term market rates in Mexico have fallen below the benchmark policy rate on the back of a worsening growth outlook.
Most policymakers thought Mexico had to take the stance of the Fed into account in setting local policy. "Most board members argued that while interest rates in our country have been adjusted downwards, rate differentials between Mexico and the United States remain high, which could induce unnecessary hardening of monetary policy," the minutes said.
Still, some members of the board said they could not rule out continued weakness in the peso, which has slumped more than 6 percent since the end of July. August was the currency's worst month since early 2009. Banorte-Ixe analyst Delia Paredes said even though the central bank had taken a leaf out of the Fed's book in giving a signal about future policy, she did not expect a knee-jerk reaction if the Fed introduces further easing. "In Mexico we don't think that Banxico blindly follows the Fed," she said.