Banxico weighing Fed tightening prospects against low growth

In a recent communication, Banxico's Deputy Governor Javier Guzman hinted that the bank could closely follow Fed actions in order to pre-empt the potential volatility and its impact on the MXN rather than wait to see the impact of Fed tightening on the domestic economy (prices in particular) before deciding its own policy moves. Under that scenario, it is observed that, the upside risk of Banxico beginning the tightening cycle earlier than current forecast of Q1  given that US economists continue to expect Fed tightening starting in September 15. The possibility that the Banxico could follow the Fed more than the domestic developments was also based on the notion that the downside risks to Mexican growth remains contained while the possibility of sharp inflation acceleration in the medium term remains benign despite substantial peso depreciation.

Recent releases on growth indicators in the US and Mexico have weakened that argument somewhat. Fed timing remains the most crucial policy mover for Banxico, but would it be easy for the bank to ignore the renewed growth weakness while inflation remains below target and core inflation at historically lowest level. Although the base effect will likely bring it back to the target early next year, the labour market slack will keep it from rising meaningfully in the medium term. The Banxico will have to ponder if following Fed is the best strategy or if the economy needs more time to accelerate, says Societe Generale.