Mexico’s Pre-empting uncertainties, Banxico could opt to follow Fed

Mexico's progress on three fronts could affect the timing of Banxico's first rate hike. The first factor relates to growth and employment, which had led the bank to cut rates significantly in this cycle. An output gap persists in the product market, while there is still slack in the labour market. Second, inflation is close to Banxico's target despite the significant depreciation of the peso, and core inflation and year-ahead expectations suggest no immediate and significant threat on this front. The third factor is the timing of the beginning of the Fed's tightening cycle, which could increase financial market volatility and put further pressure on the peso, necessitating an adequate policy response by Banxico, notes Societe Generale.

In the absence of any major progress on the first and second factors, it's the third factor that could affect the timing of Banxico's first rate hike - something hinted at by Deputy Governor Javier Guzman in a recent communication. While the pass-through effect of MXN depreciation on inflation is estimated to be quite low, the communication suggested that this is largely a grey area, with uncertainty surrounding the extent of additional pressure on MXN and its ultimate impact on inflation. What this does imply, however, is that Banxico could decide to closely follow the Fed's actions in light of the uncertainty. Accordingly, Banxico has revised its policy meeting dates so that they come soon after FOMC meetings. It is expected the first Fed rate hike at the September meeting, which presents upside risk to first rate hike in Mexico in Q1.  Banxico could raise rates earlier than expected, says Societe Generale.