Drought behind Banxico rate hike as climate threatens price stability

July 1, 2021|Written by Graham Caswell|Banco de Mexico, Banco Central do Brasil

The Banco de Mexico (Banxico) has identified the country’s ongoing drought as an inflation risk behind a surprise interest rate rise last week. Pressure from the drought on agricultural and livestock product prices was one of five inflationary risks identified, but was the only new risk listed as the central bank raised borrowing costs a quarter point to 4.25% in its first rate increase since 2018.

The drought currently affecting 85% of Mexico is the worst in decades and is particularly severe in the northern agricultural region. Lack of rain has already caused substantial drops in agricultural production with consequent rises in the prices of food and other agricultural products, and conditions are forecasted to deteriorate further. Although direct attribution is not available, drought, water security, heat stress and a dramatic reduction in cropland suitability have been identified as the greatest threats facing Mexico as a result of the unfolding climate crisis.

Banxico Deputy Governor Gerardo Esquivel confirmed the climatic effect on Mexican price stability, saying that the drought appears to be “part of the shocks we’re seeing that affect inflation” and warning that climate change could make price swings more erratic in the future. Mexico places more weight on food in its inflation basket because high levels of inequality boost the importance of food prices, Esquivel said, pointing out that while the US Federal Reserve has said climate events won’t directly affect monetary policy, Mexico has made no such pledge.

Although the Banxico interest rate decision was split, recently released minutes of the May meeting of the Bank’s Governing Board revealed that “most members warned about the impact of droughts on livestock and agricultural production, which would exert upward pressure on non-core inflation.” Irene Espinosa, also a Deputy Governor at the Bank, has been particularly outspoken about the inflationary impacts of the drought. “The spike we’ve seen in fresh food as a result of climate change should remind us that central banks also have a role to play in sustainable financing and reducing the risks of climate change,” she said in a Bloomberg interview last month. “This can turn into a snowball that generates bigger inflationary pressures.”

The Banxico move follows recent rate increases by the Banco Central do Brasil (BCB), partly in response to the worst water crisis in nearly a century, which has helped drive food price inflation. The effects of Brazil’s drought on hydroelectric generation has also caused an energy crisis, identified by the BCB as a threat to Brazilian economic growth. “We are talking about an energy crisis in Brazil again, because it’s not raining enough,” BCB President Roberto Campos Neto told an online event last month. “This has an effect on inflation, on food prices,” he said. “It is very tied to our mandate.”

This page was last updated July 1, 2021

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