US President Trump announced a tariff rate of 5% across the board on all imports from Mexico starting June 10 and will rise to 25% by October. BBVA analysts argue that incremental tariffs would likely push the Mexican economy into a recession, while at the same time inflation risks, an overly hawkish Banxico and fiscal constraints would limit the room for countercyclical fiscal and/or monetary policies.
“The incremental rise in the tariff rate (by 5% each month until it reaches 25%) unless Mexico “substantially stops” migration flow to the US is more uncertain. Yet, the progress would be “solely judged” by the US government and given that the time windows are so short and the problem so big, the chance that the tariff rate increases is not low but is not the base case scenario at the moment as Mexico will push for negotiation and will likely attempt to show results on the southern border.”
“The negative effect on the Mexican economy would mainly be through the investment channel and its magnitude ultimately depend on two factors: i) the tariff rate, and ii) on how the exchange rate (ER) reacts. The flexible exchange rate will work as a shock absorber to limit the effects on the trade channel. The impact of the potential starting tariffs of 5% would likely be offset by a further depreciation of the Peso (from the current 3% to 5%). Since the 5% tariff rate would be imposed across the board, a depreciation of a similar magnitude (with a likely overshooting due to heightened uncertainty) should help offset the effect on exports without introducing distortions within sectors.”
“The possible approval of the USMCA has less significance now. Even with an agreement in place, investors would know that trade restrictions may come at any time and for any reason.”
“Banxico should not react neither intervening with reserves to try to limit the Peso depreciation (which would be pointless and ineffective) nor through monetary policy as it would not stop potential depreciation and if anything would only partially limit the shock absorber purpose of the flexible exchange rate. In short, these measures would be ineffective and would have a cost.”
“The tariff threat is likely a game changer for monetary policy. We were expecting Banxico to start easing monetary policy later this year. This will not happen following Trump’s announcement. That is, there is little room for a countercyclical monetary policy in the short term, and the room for fiscal policy seems even more limited on a more permanent basis.”