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According to the Research Department at BBVA, a positive outcome of NAFTA negotiations would lead to MXN strengthening. In that scenario, they see Banxico holding the key rate at 7.75% over the rest of the year.

Key Quotes:  

“After two 25 bp hikes in the reference rate at the monetary policy meetings in February and June, at its last meeting (on 2 August) Banxico’s governing board unanimously decided to hold the rate unchanged at 7.75%. Although Banxico is being cautious, the tone of its statement still being hawkish, and the door being left open to fresh hikes if necessary (monetary policy will be adjusted “in a timely and firm manner”), the tone of the latest statement is less restrictive than it has been on previous occasions and shows signs that, in the absence of any further decline in the balance of risks for inflation, a monetary pause is the most likely scenario in the coming quarters.”

“Banxico is comfortable with both the current level of the reference rate and recent developments in inflation in spite of the temporary spike in headline inflation. Moreover, the recent hardening of the peso given the improvement in prospects for NAFTA 2.0 should also contribute to a lowering of expectations of inflation from market measures, which have recently increased.”

We still think that developments for the peso (MXN) will continue to be a key factor in future decisions. If, as we expect, the MXN does not weaken over the remainder of the year, we consider a further rise in rates to be unlikely, even if possible supply shocks slow down the pace at which inflation draws close to the 3% target even more.”

“If the promising tone of NAFTA negotiations continues, the MXN will consolidate its recent appreciation. A positive outcome would lead to further strengthening. On the other hand, if negotiations become difficult again, a potential significant weakening of the MXN would re-open the door to possible additional rate hikes.”

“In a context where we expect inflation to return to a falling trend, and assuming that the spread between Mexican and US rates will remain large, we would expect a sustained pause, which might run to the next three quarters. In 2019, with inflation at levels below 4% and gradually drawing close to the target, Banxico will be able to calmly consider a gradual adjustment of the policy rate to its neutral level (around 5.5%). We therefore foresee a 75 bp cut in the policy rate to 7% in 2019. This scenario is based not only on our forecasts for inflation, but also on the assumption that NAFTA will not collapse, which remains the chief risk to our scenario.”