Finance counsels

Mexico’s central bank will probably slow the pace of cuts to the benchmark interest rate as above- target inflation restricts policy makers’ response to the economy’s deepest slump since 1995.

The bank’s board, led by Governor Guillermo Ortiz, will lower the overnight rate today for a seventh straight month to 4.5 percent from 4.75 percent, according to all 22 economists surveyed by Bloomberg. Including a half-point cut in June, the bank has trimmed borrowing costs by 3.5-points this year

Today’s cut will probably be the bank’s last of 2009 on concern additional reductions aimed at sparking a rebound in Latin America’s second-biggest economy may only serve to push up consumer prices while failing to revive growth, said Benito Berber, an economist at RBS Securities Inc.

“Even though the economy is collapsing, inflation has been particularly sticky,” Berber, who is based in Greenwich, Connecticut, said in a telephone interview. “That really limits the central bank’s degree of freedom.”

Policy makers are likely to only cut a quarter point today because they said in last month’s decision that future moves might be smaller, said Alberto Bernal, the head of fixed income investments at Bulltick Capital Markets in Miami. The bank added that its easing cycle was “close to ending.”

The bank will keep the rate at 4.5 percent for the rest of the year, according to the median forecast of economists surveyed by Citigroup Inc.’s Banamex unit.

At 4.75 percent, the rate is the lowest since Ortiz began targeting the overnight lending rate in 2005. Previously, Banco de Mexico implemented monetary policy by targeting the money supply through a system known as the “corto.”

Economy

Latin America’s second-biggest economy has plummeted and job losses have accelerated this year as the recession in the U.S., which buys about 80 percent of Mexican exports, saps demand for its products.

In the first quarter of the year, the $1.09 trillion economy shrank the most since the Tequila Crisis 14 years ago. Industrial output has tumbled for nine straight months and sales of goods abroad have fallen by a third in the last year. Money transfers from abroad dropped 20 percent in May, the largest fall on record faxless payday loans.

Banco de Mexico says the economy may have contracted 10 percent in the second quarter, even as the government says it sees signs the slump is ending.

Goldman Sachs Group expects the economy to shrink 8.5 percent this year, the biggest annual contraction since 1932.

The swine flu outbreak in April and May also battered the economy as the government shut schools, restaurants and theaters and foreign tourism revenue plunged. The flu may reduce gross domestic product by 0.5 percent this year, according to Ortiz.

Inflation

Mexico’s annual inflation rate slowed to 5.74 percent in June, the lowest in nine months. While the rate was within the central bank’s forecast of 5.5 percent to 6 percent in the second quarter, it was above policy makers’ forecast of no more than 5.25 percent for the third quarter.

The bank aims to meet its inflation target of 3 percent by the end of 2010.

Ortiz said in an interview last month that inflation will slow at a “rapid rate” and that a recent rise in global commodities prices is “less threatening” than when those costs reached their peak.

Still, the government may add an extra half point to the annual inflation rate if it raises gasoline prices to compensate for higher international costs, said Gabriel Casillas, chief economist for Mexico and Chile at UBS AG.

Officials said in January they would freeze gasoline prices for the whole year.

Slower Pace

The bank will probably slow the pace of cuts today and then pause because the real interest rate, which factors in the inflation rate, is negative, said Bernal at Bulltick.

“Since Mexico’s inflation is still high, the nominal interest rate can’t be as low as one would hope,” Bernal said. “We all want to see Mexico cutting rates to zero. But that’s very unlikely because Mexico’s inflation rate is still sticky.”

Lower interest rates can help prompt businesses to invest and consumers to buy on credit. Cheaper loans also can spur inflation by strengthening demand.

Source

Filed under: finance by Guru