Mexico's Central Bank Surprises with Rate Cut Despite Rising Inflation

Mexico's central bank, known as Banxico, shocked markets on March 27 by cutting interest rates 25 basis points to 6.75%, even though inflation is running at 4.63%, well above the 3% target.

The decision was highly controversial within the bank itself. The vote was 3 to 2, with two board members dissenting. That's about as divided as central bank decisions get. Deputy Governor Jonathan Heath voted against the cut, arguing that inflation is still too high and cutting rates now risks losing credibility.

Why did the majority vote to cut? They're worried about economic growth. Mexico's economy has been slowing for months. Manufacturing output fell 2.1% in February. Retail sales are weak. Unemployment is creeping higher. The central bank projects GDP growth of just 1.5% to 2.5% for 2026, down from over 3% in 2024.

The peso immediately weakened to 17.95 against the US dollar, down from 17.80 before the announcement. A weaker peso makes imports more expensive, which could push inflation even higher. That's the risk the doves on the board are taking.

Inflation in Mexico peaked at over 8% in 2022 during the global inflation surge. Banxico raised rates aggressively to 11.25%, the highest in over a decade. They've been cutting slowly since mid 2023 as inflation came down. But at 4.63%, inflation is still well above target and has been stuck there for months.

The March inflation report showed core inflation, which strips out volatile food and energy, at 4.5%. That's the sticky kind of inflation that doesn't go away easily. Services inflation is running at 5.2%, driven by wage growth and rising rents.

Bond markets reacted negatively. Mexican 10 year government bond yields jumped 15 basis points as investors worried that Banxico is prioritizing growth over price stability. If inflation doesn't come down, future rate cuts could be off the table.

Some economists think Banxico is making a mistake. Goldman Sachs warned that cutting rates with inflation still elevated could force the central bank to reverse course and hike again later, which would be embarrassing and damage credibility.

Others argue the cut makes sense. Mexico faces headwinds from weak US demand, the Iran war disrupting global trade, and domestic political uncertainty ahead of elections. If the economy slides into recession with rates at 7%, the central bank would have less room to respond.

For Mexican consumers and businesses, the rate cut means slightly cheaper borrowing. Mortgage rates might tick down a bit. Credit card rates could ease. But if inflation stays high or goes higher, any benefit from lower rates will be eaten up by rising prices.

The peso's weakness is a wildcard. A falling currency pushes up import prices. Mexico imports a lot of goods from the US and China. If the peso keeps weakening, inflation could accelerate, forcing Banxico to reverse the cut.

This decision will be heavily scrutinized. If inflation falls over the next few months, the doves will be vindicated. If it stays elevated or rises, the hawks will say I told you so.