2016.09.2807:35:00UTC+00Banxico Likely to Keep Overnight Rate on Hold on Thursday

The Bank of Mexico, during its policy review meeting tomorrow, is expected to keep the overnight rate on hold; however, the upside risk is high, according to Societe Generale. The recent growth indicators and the detail of the second quarter GDP imply that the Mexican economy is expanding quite below its trend level and that it is slowing further. Unless the U.S. economy rebounds from here, the Mexican economy is expected to slow down further. While the growth outlook continues to be sluggish, Mexico’s inflation continues to lag behind the Banxico’s target on structural and cyclical reasons.

The downside risk to the inflation outlook remains because of the continued impact of low telecom prices on the dwelling component. Amongst other major components, transport inflation rises recently on account of the government-induced increase in administered sub-components. Broadly, the medium-term inflation outlook is stable, stated Societe Generale.

Since December 2015, the Bank of Mexico has hiked the interest rate by a total of 125 basis points. The rises in the interest rate were partially a response to manage the spread with the Fed funds rate, taking the overnight rate to 4.25 percent and the spread with the U.S. Fed funds rate to 3.75 percent. But the rate hikes were mainly implemented to steady the peso that came under severe pressure after market expectations of Fed tightening, declining in oil prices in 2015 and several other factors, added Societe Generale.

Under such a scenario, a pre-emptive tightening by the Mexican central bank is a close call as compared to the current projection of the next tightening in December. It is quite likely that the central bank might hike rates further to steady the currency, and the possibility of an early hike is rising, said Societe Generale. Furthermore, there is a rising probability that the total rate hike in 2016 might be higher than current projection.

“We maintain our forecast of no rate change in September in the wake of weak 2Q GDP details. However, the growth moderation is unlikely to keep Banxico from holding the rate unchanged for long if the peso remains under such pressure”, noted Societe Generale.