Banxico Raises Interest Rate to Historic Levels

As part of its continued efforts to contain inflation in the country, the Bank of Mexico (Banxico) announced a new interest rate, increasing it to historic levels.

Prices in July showed their strongest rebound in 21 years, reaching an annual increase rate of 8.15 percent. On the back of this development, Mexico's Central Bank toughened its monetary policy in another effort to contain inflation and bring it back to its target of around 3 percent.

Similar to the increase in June, the latest interest rate increase equaled 75 basis points, setting it at 8.5 percent. In the 14 years that Banxico has used the interbank interest rate as a monetary policy, this is the second-highest increase and the first time it has exceeded the 8.25 percent ceiling, seen only after the 2008 economic crisis.

The rate increase was unanimously voted through by Banxico's Board of Governors, who noted that the conduct of monetary policy faces "greater challenges" represented by financial conditions globally, geopolitical conflicts and inflationary pressures that built up during the COVID-19 pandemic.

"The Board of Governors evaluated the magnitude and diversity of the shocks that have affected inflation and their determinants, as well as the evolution of medium- and long-term expectations and the price formation process," said Banxico.

This is the tenth consecutive increase made by Banxico since mid-2021, a year when inflation surpassed the institution's target range after remaining under control for months due to the effect the COVID-19 confinement had on product demand. Since June 2021, Banxico has increased its rate by 4.5 percent.

Inflation forecasts for the rest of 2022 and the first half of 2023 also changed. Banxico estimates that in the 4Q22, inflation will close at 8.1 percent. Previous estimates stood at 7.5 percent. Inflation is expected to drop back to the target in 4Q23, when it will reach 3.2 percent annual growth.

Days before Banxico's announcement, the National Institute of Statistics and Geography (INEGI) reported that inflation in July reached 8.15 percent, a level not seen in nearly 20 years. However, analysts estimate that inflation will continue to rise until reaching its peak between August and September 2022, when it reaches 8.5 percent annually.

With monetary policy tightening, it will be more expensive to borrow, and those with variable interest rate loans will see an increase in their debt collection. These factors will likely cause consumption levels to slump.

However, the higher rate will benefit savers, as they will have a higher rate for keeping their money at financial institutions. This incentivizes savings, which in turn also depresses consumption, contracting demand to achieve the eventual decrease in prices.