Bank of Mexico pauses rate cutting cycle, pushes back inflation forecast

By Brendan O'Boyle

MEXICO CITY, Feb 5 (Reuters) - The Bank of Mexico's governing board unanimously held its benchmark interest rate at 7.00% on Thursday, in line with market expectations after recent upticks in both inflation and economic growth.

The bank also said it now sees inflation hitting its 3% target in the second quarter of 2027, a notable extension from its previous forecast of the third quarter this year.

Banxico, as the central bank is known, faced both external and internal skepticism in recent months about what some had seen as overly optimistic inflation forecasts.

Banxico's revised forecasts on Thursday show higher inflation is expected throughout 2026, including headline inflation now seen closing the year at 3.5%, up from the bank's prior forecast of 3.0%.

Thursday's hold was the bank's first pause since June 2024, which was followed by 12 consecutive rate cuts. The bank began bringing down the rate in March 2024 after it reached a record high of 11.25%.

While Banxico cut the rate by 25 basis points at its December meeting, it signaled at the time an openness to pausing the easing cycle, citing uncertainty around the inflationary impact of new taxes and tariffs that were set to take effect in Mexico in January, according to meeting minutes.

Banxico's monetary policy program published last week echoed concerns from the board members about the length of the impact of the measures, including higher tariffs on imports from certain countries, namely China, and said it would likely adopt a more gradual policy approach than in 2025.

Both headline and core inflation ticked up in the first half of January, hitting 3.77% and 4.47%, respectively, both climbing further away from the bank's target.

Cigarettes and bottled soft drinks - targets of the government's new taxes - registered the biggest price increases in the period, after the tax bump went into effect. Mexico's statistics agency will publish full-month data for January on Monday.

Banxico's overall tone on Thursday was hawkish, but the decision likely marks just a pause, not the end, of its easing cycle, Capital Economics' Liam Peach said in a note to clients.

"It doesn’t close the door on the easing cycle, but it will be stop-start, and the timing of the next move may depend on an improvement in the inflation outlook," Peach said.

Analysts polled by Reuters had expected the rate hold, due to both the uptick in inflation as well as Mexico's improving economic prospects.

Mexico's sluggish economy had in recent decisions been a reason for some Banxico governors to cut the rate. But data published last month showed Mexico's economy rebounding in the fourth quarter of 2025. While still weak, the economy's 0.8% quarterly growth in October to December was its strongest performance since the third quarter of 2024, fueling analysts' expectations for a rate hold.

Analysts largely see Banxico holding the rate for much of 2026. Those polled by the central bank in late January forecast the benchmark rate ending both 2026 and 2027 at 6.50%.