Bank of Mexico Surprises With Rate Cut

By Dow Jones Business News, 
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MEXICO CITY--The Bank of Mexico surprisingly cut its benchmark lending rate by half of a percentage point Friday to a record low 3% to help jump-start an economy that has failed to recover so far this year.

The rate cut, the first since October, came as a surprise to a market that had expected the central bank to stay on hold given the gradual reduction in the U.S. Federal Reserve's monetary stimulus, which will make emerging market assets less attractive as dollar yields rise.

The Bank of Mexico, led by Gov. Agustín Carstens, said it doesn't foresee any further rate cuts given the expected improvement in the Mexican economy and the U.S. tapering of bond purchase. The Mexican central bank leaned on Fed assurances that its "normalization of monetary policy will be gradual."

The Fed has been reducing the amount of Treasurys and mortgage-backed securities that it buys each month to shore up the U.S. recovery, but is expected to keep its benchmark lending rate near zero well into 2015.

"Today's bold move suggests that the board is now less concerned than what it had indirectly been suggesting, that rate cuts in Mexico would run the risk of tightening the domestic-foreign interest rate differential excessively and destabilizing the peso and investor appetite to remain engaged in local assets," said Goldman Sachs economist Alberto Ramos.

Mexican Finance Minister Luis Videgaray, who has gone to some lengths trying to reassure Mexicans and investors that the desired economic growth will eventually occur, welcomed the rate cut as a timely decision that will encourage growth and investment by lowering the cost of borrowing.

The decision takes advantage of low inflation, and is consistent with what other central banks are doing, he told reporters during a visit to Portugal, noting that the European Central Bank cut rates this week and adopted other measures to stimulate the euro-zone economy.

The Mexican peso weakened following the rate decision, jumping from 12.8360 pesos to the dollar to around 12.9260 pesos, before settling back to around 12.90 pesos. The local stock market gained, with its leading IPC index recently up 1.3%, while the yield on 10-year government bonds fell 32 basis points to 5.61%.

The central bank said that with inflation risks diminishing, the lower interest rate is unlikely to hinder a move toward its 3% target by early 2015. The consumer-price index was up 3.4% in the 12 months through mid-May.

A pickup in exports toward the end of the first quarter hasn't been enough to compensate for weakness in domestic consumption and investment, the central bank said, adding growth in 2014 is likely to be less than what was expected " just a couple of weeks ago."

Last month, the central bank lowered its growth estimate for 2014 to 2.8% from 3.5%, which implies the creation of 50,000 fewer jobs this year than previously thought. Gross domestic product grew at an annualized rate of 1.1% in the first quarter and was up 1.8% from a year before, below central bank forecasts for the quarter.

The Finance Ministry lowered its growth forecast to 2.7% from 3.9% following the first-quarter data.

The delayed recovery has proved to be a disappointment to investors who were encouraged by the government's agenda, including opening the state-run oil industry to private investment for the first time in decades.

"By now most Mexico watchers seem to approach every call for a recovery with great skepticism--it will happen eventually, but unwilling to pound the table on it," Morgan Stanley economist Luis Arcentales said Friday in a report ahead of the central bank's decision. "Yet after a careful review of the likely causes for this year's stagnation and looking at the growing number of green shoots, we come away confident that the worst of the sluggishness may finally be behind us."

Write to Anthony Harrup at anthony.harrup@wsj.com

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This article appears in: Economy , International


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