Bank of Mexico unexpectedly cuts key interest rate

The Bank of Mexico (Banxico) cut its key interest rate by 25 basis points to 6.75% in a divided decision, leaving the door open for a further cut as economic and financial conditions warrant. The central bank also revised its inflation forecasts for the first and third quarters of this year upward, while maintaining its projections for 2026 and 2027. The announcement was a surprise, as while analysts were divided, consensus leaned towards a pause following a recent rebound in inflation and uncertainty surrounding the situation in the Middle East. "The question is which prices within the basket of goods used to measure inflation are under pressure and what is the expectation regarding the duration of that pressure," an analyst questioned. He noted that the central bank may have considered the January IGAE data, which shows significant economic weakness, in its decision, and that if the economy weakens, demand pressures on prices also ease. It was emphasized that Banxico is signaling its intention to make another adjustment to bring the rate to 6.50% this year. Subgovernors Galia Borja and Jonathan Heath voted against the cut. The central bank explained that it reduced the rate in line with its assessment of the current inflationary landscape. It considered the observed levels of the exchange rate, the weakness shown by economic activity, and the degree of monetary restraint that has been implemented. It also judged that the monetary stance achieved would be appropriate to face the challenges derived from a prolongation and escalation of the conflict in the Middle East and its repercussions. "Going forward, as the evolution of macroeconomic and financial conditions warrants, the Board will evaluate the appropriateness and timing of making an additional cut to the target rate," it reiterated. Alonso Cervera, Executive Director of Studies and Public Affairs at Santander México, said that while opinions among economists were split 50/50 on a rate cut, Banxico's decision to lower the rate was a surprise, especially for the rates market, which was pricing in no change. "From the perspective of asset prices, it was a surprise this cut," he emphasized in an interview on the Ganadores y Perdedores program on El Financiero TV. Economists at Banamex agreed that the central bank's determination was surprising and warned that the Board is underestimating the magnitude of inflationary pressures, as well as the fact that inflation and its expectations will remain far from the target; it also underestimates the upside risks that prevail. For Liam Peach, senior emerging markets economist at Capital Economics, Banxico's decision and language were surprising, but showed that while it has room to cut rates, it is in no rush to do so. Economists at HSBC stated that the most relevant change was in the forward-looking message: Banxico adjusted its guidance and showed itself to be less "dovish" (less inclined to continue cutting rates quickly). Upside inflation risks Víctor Gómez Ayala, chief economist at Finamex, explained in an interview that the balance of risks for inflation, as recognized by the Board of Governors, is skewed to the upside. The Bank of Mexico cut its reference interest rate by 25 basis points to 6.75% in a divided decision and left the door open for an additional cut as macroeconomic and financial conditions allow. Additionally, it revised its inflation forecasts for the first to third quarters of the current year upward and maintained its forecasts for all of 2026 and 2027. The announcement was a surprise, as the analyst consensus, while divided, was leaning towards a pause after the recent rebound in inflation and uncertainty regarding the situation in the Middle East. Governor Victoria Rodríguez and Subgovernors Gabriel Cuadra and Omar Mejía voted in favor of the rate cut. "But the moment to execute that cut is still very uncertain." On the other hand, Cervera ruled out a stagflation scenario in Mexico, by pointing out that the economy is expected to strengthen throughout the year, bolstered by spending associated with the FIFA World Cup and a lesser restriction on public investment. He projects that GDP will grow in 2026 by 1.5 percent, well above last year's 0.6 percent.