But given this, an important question arises: what will Banxico’s floor or terminal rate depend on? Will it depend on inflation?
Without a doubt, within the equation is the inflation variable, but it is probably not the only variable, the Federal Reserve (Fed) rate will also be fundamental in the floor of the Banxico rate, why? Due to the differential in interest rates between Banxico and the Fed.
The interest rate reflects the cost of money. In emerging markets, bond yields are regularly positive and more attractive than in developed countries. In that sense, the yield of what Banxico pays against the Fed is much more attractive, but variables such as country and exchange risk must also be considered.
Over a time horizon, if the Fed increases the interest rate in the short term and inflation does not converge around 2% in the medium term, the Fed’s interest rate could remain higher than the market would expect and It would undoubtedly limit the floor of emerging market interest rates.
The market and analysts could reach a consensus on how much the interest rate would be in the short term, but the fundamental point of debate will be the consensus rate level that will be found in the medium and long term.
Banxico’s interest rate could fall as quickly as inflation subsides, especially core inflation; In that sense, if inflation converges to its target of around 3%, the interest rate could not fall at the same pace as inflation because the reference point will be the Fed rate in 2025.
That is, from the medium term, the speed and terminal rate of the Banxico rate will be guided by the rate differential that Banxico must have with the Fed, which has been on average around 400 basis points.