For the remaining quarters, the forecasts remained unchanged, so the Bank of Mexico continues to expect the anticipated convergence of inflation to the 3.0% target by the second quarter of 2027. The economy’s slack capacity remains the justification for the rate cut, and the statement reiterated the absence of second-order effects from the tariffs implemented in Mexico at the beginning of the year.
Several points of discussion arise from this decision, beginning with the slack capacity and its impact on price formation. Intuitively, low economic growth contributes to inflation, but higher economic growth is anticipated for 2026, boosted in June and July by the World Cup. Accelerated growth could put upward pressure on inflation, particularly in the services sector, which has shown reluctance to fall toward the 3% target.
Second, the Bank of Mexico’s Governing Board makes its monetary policy decisions based on expected inflation, which, according to its own forecasts, will return to the 3% target within a year. However, no analyst expects inflation to return to the 3% target by 2027. Only the Ministry of Finance anticipates such a scenario, but it is well known that its projections are also highly optimistic.
This reflects that analysts have stopped paying attention to the Bank of Mexico’s forecasts. This is highly relevant, since one of the main channels for transmitting monetary policy is expectations, and with less confidence in the central bank, it will be more difficult to bring inflation to the target.
Third, each central bank estimates the levels of real interest rates at which monetary policy is restrictive, neutral, or expansionary, which allows it to curb, remain neutral in the fight against inflation, or encourage it. To determine the rate, the real ex-ante rate must be calculated, that is, taking the nominal benchmark rate (currently at 6.5%) and expected inflation. This last point is crucial. Inflation expectations, as mentioned earlier, differ between analysts and the Bank of Mexico.
Using the Bank of Mexico’s forecast, the ex-ante real interest rate is 3.44%, while using the inflation expected by analysts surveyed by the Bank of Mexico, it is 2.66%. Both rates are in neutral territory, but the analysts’ forecast has remained there for eight months. Considering the lag with which monetary policy operates, this suggests that it is very possible that inflation is no longer being actively combated.
Fourth, currencies are not backed by anything. They are only backed by confidence in the economy that issues them. Therefore, with low and stable inflation, the purchasing power of the currency is maintained. If high inflation is not addressed, confidence in the currency can be lost, making it more vulnerable to disorderly depreciations that would generate distortions, affecting relative prices for international trade and price formation in Mexico.
With the rate cut, the interest rate differential between Mexico and the United States also narrowed to 275 basis points, the lowest since February 2016. A smaller differential discourages carry trades and increases vulnerability, potentially making the exchange rate less stable in the future. This, coupled with higher inflationary pressures, adds risk for those with savings and investments in pesos.
Finally, it has been widely argued that recent pressures are concentrated in the non-core component, over which monetary policy has no influence. This is true, but it does not mean there are no pressures on the core component, which determines the inflation trajectory in the medium and long term.
For example, core inflation has been above 4% for 12 consecutive months and has been outside the 3% target for 116 consecutive months. It is worth remembering that the Bank of Mexico’s target is 3%, and the +/- 1% margin of error should not be considered a tolerance range, although in practice many treat it as such.
Source: revista.imef
