Mexico sees a rise in inflation and the central bank runs out of weapons

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Inflation stands at 4.09%, above Banco de México’s target and experts warn that it will rise even more in the coming months, driven by an adjustment to food prices and a new minimum wage

The Mexican economy is, as in many other countries in the world, in recession. However, for Mexicans, the cost of things has risen during the pandemic and, according to several economists, will continue to rise until the middle of next year, complicating the already precarious situation for millions of families who have seen their incomes fall dramatically. during the economic crisis caused by the pandemic. It is up to the central bank to contain inflation, but it now has few tools to deal with it.

Unlike other central banks in the world, especially the Federal Reserve of the United States, the Bank of Mexico does not have within its responsibilities to stimulate the economic growth of the country. Although the bank seeks not to affect the economy in a negative way, that is not its priority. The bank has two mandates: first, to prevent inflation from skyrocketing and, second, to ensure that the financial system has the necessary liquidity for its operation. To achieve this, you have a powerful weapon: the interest rate. When defining it, the rest of the banks use it as a reference in transactions and investment instruments. A high rate can contain inflation, since it becomes an incentive in favor of saving and against debt. A low interest rate can allow inflation to rise, while stimulating economic growth. What the bank seeks to avoid is that the economy grows so much and so fast that it “overheats” and inflation soars. It is a lever that moves with millimeter precision.

Since August 2019, Banco de México has cut the interest rate from 8.25% to the current 4.25%. At its last monetary policy meeting on November 12, where its governing board voted to make a decision, it was decided to pause the cuts, citing the start of an economic recovery. Interest rates also make Mexico an attractive investment for both domestic and foreign investors seeking returns, so they are always high or low in relation to the rates offered by other countries.

The situation is getting complicated for Banco de México because inflation will be sticky high until at least mid-2021, explains Marco Oviedo, head of Economic Research for Latin America at the English investment bank Barclays. During the pandemic, Mexicans spent on food what they used to spend on entertainment or restaurants, says Oviedo, which led to an increase in inflation that will continue next year when, once a large part of the population is vaccinated, the gastronomic industry starts back to full capacity and have to adjust your prices to new food costs. In addition, the price of the corn tortilla, basic in the diet of Mexicans, will rise by at least one peso, starting next December, which will have a significant impact on the pockets of the population.

“To this, let’s add that energy inflation is in negative terms this year due to the fall in oil prices. Next year, even if gasoline rises 3%, according to expected inflation, there will be a base effect, “he says on the phone from New York,” inflation can go up to 5% around April and May or June. ” . According to the National Institute of Geography and Statistics (Inegi), inflation in October stood at 4.09%, already slightly above the central bank’s target range of 3% plus or minus one percentage point.

One more component that will drive inflation is the federal government’s promise to increase the minimum wage, as it did during 2019 and 2020, by 20% and 16%, respectively. It is proven that, although the effects of the adjustments made by the Government in the last two years have been limited, they have caused core inflation not to fall as fast as it should have fallen, explains Oviedo.

For Banco de México to avoid a divestment of financial instruments that today enjoy a yield of 4.25%, it cannot lower its rate much further. The Mexican rate is more attractive than, for example, that of 2.25% offered by Brazil, but less attractive than that of Turkey, which is at 10.25%. The Mexican central bank does not have many weapons left to combat inflation and, at the same time, prevent capital outflows, Oviedo believes.

“If there is room to cut, we would be talking about maybe 50 basis points more,” says the expert, “and Banxico has been very clear that obviously other types of policies are needed to stimulate the economy. The monetary one cannot fall everything on them and I believe that there is not much left to do ”.

The pandemic hit Mexicans in their finances, says Juan Carlos Alderete, director of Economic Analysis at Banorte. “However, and in this context, I believe that Banco de México has done a very good job maintaining price stability and without inducing major shocks that further affect the real income of families,” said the economist from Mexico City. Alderete also expects a rise, albeit moderate, in inflation in the coming months and the consequences should not be minimized.

“Inflation is similar to a tax that affects all people, but especially those with lower incomes,” says Alderete, “high and unpredictable levels of inflation raise uncertainty about the best way to use said income. Ultimately, this affects the behavior and decisions of consumers and companies, generating distortions in incentives that in turn affect the well-being of the entire population ”.


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