Banco de Mexico board of governors cuts overnight interest rate to 3½%

By Caroline Salls

Pittsburgh, Oct. 25 - The board of governors of Banco de Mexico reduced the bank's overnight interest rate by 25 basis points to 3½%, according to a news release issued by the bank.

This is the second time in as many months that the rate has been reduced. Last month, the board reduced the rate 25 basis points to 3¾%.

The board said the world economy has continued to show weak growth, and in the United States the expansion in economic activity appears to have moderated as a result of a slowdown in private domestic demand.

Given this, and taking into account the uncertainty surrounding the fiscal debate, the board said the Fed left its pace of asset purchases unchanged in September and said it would wait to have more evidence of the improvement of the economy and labor market before adjusting the rate of those purchases.

The bank said this decision led to a temporary interruption of the decompression risk premium process, resulting in a decrease in interest rates and the long-term recovery of international financial markets.

However, the board said the financial markets are expected to continue to be affected in the coming months by the uncertainty associated with discussions on fiscal and monetary policies in the United States.

The bank said the business outlook index and household confidence in the euro area point to a slight recovery in the economy, while growth in emerging economies has been less than anticipated, in some cases because of macroeconomic vulnerabilities.

On balance, the governors said there are prevailing downside risks to global economic growth. With the absence of significant pressures on commodity prices, the board said a low global inflation outlook is expected.

Economic activity

According to the release, economic activity in Mexico showed a sharp slowdown in the first quarter and a contraction in the second, but some indicators suggest that the economy began to show recovery in the third quarter.

The board said this shows that some of the adverse shocks that manifested from the second half of 2012 have apparently begun to fade.

Despite this, the bank said a considerable degree of slack in the labor market and the economy as a whole prevails.

Inflation factors

Headline inflation in the first half of October was 3.27%. The bank said headline inflation has been below 3.5% since July.

Additionally, the board said the fading of shocks affecting non-core inflation, which, as expected, turned out to be temporary and did not have second-order effects in the pricing process of the economy, also contributed to favorable inflation developments.

The governors said inflation expectations for the end of 2014 have shown a slight increase in response to the possible effects of tax changes on some relative prices, but remain below 4%. More importantly, the board said expectations for medium-term and long-term horizons have remained stable.

Lower volatility

Since the last monetary policy meeting, the bank said the United States made important decisions on monetary and fiscal issues that caused volatility in international financial markets. In this environment, exchange and money markets in Mexico operated in an orderly fashion, which has contributed to lower volatility in the exchange rate and interest rates, as the sovereign risk premium has remained stable Mexico.

While economic activity in Mexico is expected to show a recovery in the remainder of this year and next year, the board said economic growth for 2013 and 2014 is expected to be less than the previously published projection.

In this context, the bank said it expects no inflationary pressure from the demand side in 2013 and 2014, and the effect on inflation of any tax changes will be moderate.

In the short term, the board said the possibility that economic activity in Mexico could be lower than expected could result in downward pressure on inflation.

In the medium term, the bank said progress in the structural reform process could allow higher growth with lower inflation.

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