On the trail of Banxico’s reaction function

Our analysis of Banxico’s reaction function reaffirms our forecast that the policy rate will end the year at 8.25% – 1.25ppts lower than the consensus expectation of 9.50%. We expect larger rate cuts in Q4 2024, once inflation falls within the target range.

What you will learn:

• Mexico’s central bank has finally started its normalization cycle, well behind its emerging market peers but slightly ahead of the Federal Reserve. The move ahead of the US Fed is uncharacteristic, but it supports our view that Banxico’s reaction function is changing.
• Our analysis of alternative monetary policy rules suggests Banxico’s attention has shifted back to inflation since the peak of the post-pandemic distortions in 2022. The shift seems to have been driven by the unexpected appreciation of the peso since the end of the hiking cycle in Q1 2023.
• We acknowledge the space for upside risks to our outlook is sizable as many of Banxico’s past focus variables still point to higher rates. Moreover, episodes of volatility could force Banxico to focus on stabilizing domestic financial markets.