Mexico Central Bank to Consider Larger Rate Cuts Early in 2025

The Central Bank of Mexico (Banxico) is expected to consider larger interest rate cuts early in 2025, as the economy continues to recover from the COVID-19 pandemic and inflation remains relatively low. In December 2024, the annual headline inflation rate eased to 4.21%, approaching the upper end of the central bank's target range of 2% to 4%. The core inflation rate also rose to 3.65% in December, indicating a slight increase in underlying inflationary pressures.

Banxico has already implemented four consecutive interest rate cuts, with the latest reduction of 25 basis points in December 2024. The bank's Governing Board anticipates that the inflationary environment will allow for further reductions in the reference rate, but it emphasizes the need to maintain a restrictive monetary stance.

The central bank's decision to lower the overnight interbank interest rate target to 10.0% reflects its expectations for a continued decline in inflation. However, it is essential for Banxico to monitor the impact of these rate cuts on the economy and adjust its policy accordingly to prevent any adverse effects on economic growth or inflation.

In the past, Banxico has expressed concerns about the potential risks associated with cutting interest rates too aggressively. In August 2024, Deputy Governor Jonathan Heath voted against a rate cut, arguing that reducing the interest rate before there was more certainty around the trajectory of inflation could hurt the bank's credibility. Similarly, Irene Espinosa, another deputy governor, has expressed concerns about the potential risks of cutting interest rates too quickly.

To balance the need for further rate reductions with the risk of fueling inflation or negatively impacting economic growth, Banxico must carefully consider the following factors:

1. Inflation expectations: Banxico should closely monitor inflation expectations among consumers, businesses, and financial markets. If expectations remain well-anchored, the central bank may have more room to maneuver in reducing interest rates without causing a significant increase in inflation.
2. Economic growth: The central bank should assess the impact of interest rate cuts on economic growth, particularly in sectors such as construction and financial services, which have shown strong performance in recent years. If these sectors continue to grow at a robust pace, Banxico may have more leeway to reduce interest rates without negatively impacting economic growth.
3. Global economic conditions: Banxico should consider the potential impact of global economic conditions on Mexico's economy and inflation. For example, if global economic integration reverses or geopolitical tensions increase, the central bank may need to adjust its monetary policy to mitigate the risks to the Mexican economy.
4. Fiscal policy: Banxico should coordinate its monetary policy with the government's fiscal policy to ensure that both policies work together to support economic growth and control inflation. If the government implements measures to reduce the budget deficit or increase public spending, Banxico may need to adjust its monetary policy accordingly.

In conclusion, Banxico must carefully balance the need for further interest rate reductions with the risk of fueling inflation or negatively impacting economic growth. By closely monitoring inflation expectations, economic growth, global economic conditions, and fiscal policy, the central bank can make informed decisions about the appropriate monetary policy stance to support the Mexican economy while maintaining price stability.