Banxico Holds Interest Rate Steady Amid Inflation Concerns

Key Takeaway

• Banxico maintains a cautious stance on rate cuts, holding the key interest rate at 11% due to persistent services price inflation and strong domestic demand.
• The Mexican peso declined by 0.2%, influenced by broader market sentiment and awaiting FOMC minutes, with no significant technical levels until 16.2616/USD.
• Regional central banks in Asia face challenges from the Fed's hawkish tone, complicating their monetary policy decisions amid economic uncertainties.

Banxico's Cautious Approach

Mexican central bankers are adopting a cautious stance on interest rate cuts due to persistent services price inflation and a robust job market. According to the minutes from Banxico's May meeting, at least one board member expressed reluctance to consider another rate cut in the upcoming meetings unless core inflation data shows significant improvement. Other members suggested that any further cuts should be "gradual."

Banxico held its key interest rate steady at 11% during the May meeting, following a quarter percentage point cut in March. Despite a notable slowdown in inflation from its peak in 2022, it remains above the central bank's 3% target. Consumer prices rose slightly to 4.78% in the first two weeks of May, as per data released earlier on Thursday.

The central bank has revised its inflation forecast, now expecting to achieve its 3% target by the last quarter of 2025. This adjustment reflects the impact of strong domestic demand, which continues to keep core inflation elevated. Bank Governor Victoria Rodriguez indicated that there is room for further easing, but decisions will be data-driven, leading analysts to anticipate a potential rate cut in June. Economists in a recent Citi survey predict a quarter-point cut next month.

Peso Depreciation Concerns

The Mexican peso has been edging lower, influenced by broader market sentiment and awaiting fresh insights from the Federal Open Market Committee (FOMC) minutes. On Wednesday, the peso declined by 0.2%, aligning with most of its peers amid a risk-off sentiment driven by concerns over potential new insights from the FOMC minutes and Nvidia's upcoming quarterly results.

The peso's depreciation is part of a broader trend affecting several emerging market currencies. Traders have reduced their bets on Fed interest rate cuts, now forecasting a 40 basis point reduction this year, down from a half-point reduction seen a week ago. The FOMC minutes, due at 2 pm ET, are expected to provide further clarity on these expectations.

Nvidia's much-anticipated quarterly results are also in focus, with analysts expecting a stunning 243% gain in revenue, driven by an AI spending boom. The peso has no significant technical levels to watch until it reaches its year-to-date high of 16.2616/USD, following a decline in implied volatility that has attracted bullish traders.

Impact on Regional Central Banks

The hawkish tone from the FOMC minutes has significant implications for regional central banks in Asia. The Federal Reserve's decision to maintain higher interest rates complicates the monetary policy landscape for these banks, making it challenging to justify rate cuts. For instance, the Bank of Korea is expected to hold its rates steady, reflecting a cautious approach amid uncertainty about the Fed's next steps. Similarly, Bank Indonesia recently decided to keep rates unchanged, adopting a data-dependent strategy moving forward.

In Australia and Japan, economic indicators such as the Purchasing Managers' Index (PMI) need to show continued improvement to support the Reserve Bank of Australia's (RBA) hawkish stance and to signal to the Bank of Japan (BOJ) that the economy can handle marginal rate increases. Positive data surprises in these regions could negatively impact bond markets, adding another layer of complexity to the monetary policy decisions.

Management Quotes

• Victoria Rodriguez, Governor of Banxico:

  "There’s more room for easing but that it will make decisions based on available information."