Itaú BBA - MEXICO – 1Q20 Inflation Report: higher inflation in 2020 consistent with a cautious easing cycle

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MEXICO – 1Q20 Inflation Report: higher inflation in 2020 consistent with a cautious easing cycle

May 27, 2020

We expect Banxico to continue a cautious easing cycle

The Central Bank of Mexico (Banxico) published its quarterly inflation report for 1Q20, decreasing sharply its economic growth forecast for 2020 and 2021. Amid the uncertainty around the impact of COVID-19 in economic activity, Banxico published several scenarios which depend on the deepness and duration of the negative shock in GDP, with a V, deep V and deep U scenario. For 2020 and 2021, the central bank expects a GDP of -4.6% and 4.0%, -8.8% and 4.1% and -8.3% and -0.5%, in a V, deep V and deep U scenario, respectively. 

Higher inflation for 2020, but lower for 2021. Three Inflation projections were constructed using the assumptions behind the aforementioned GDP scenarios. The inflation projections included in the report represent the center scenario of those predictions. The quarterly average annual headline and core inflation forecasts for 4Q20 increased to 3.5% (from 3.2% in the last inflation report) and 3.8% (from 3.0%), respectively. According to the report, the upward revisions are due to the still persistence in core inflation, the effect on prices from the depreciation of the currency and a supply shock on prices due to distancing measures amid the outbreak. However, for 2021, the central institute expects a fast deceleration in inflation dragged by the widening of slack conditions.  The quarterly average annual headline and core inflation forecasts for 4Q21 remained unchanged at 3.0% and decreased to 2.6% (from 2.9%), respectively.

The balance of risk for inflation remained uncertain (compared to the last monetary policy statement), while more downside and upside risks to inflation were added. On the downside risks for inflation list, besides the widening of slack conditions and lower energy prices, a continued appreciation of the currency and lower imported prices (given the weak global economic activity) were added. On the other hand, a larger demand for certain goods and an increase in production costs amid the outbreak were included in the list of upside risks for inflation (the list already included a persistent depreciation of the currency and disruption in supply chains). 

We expect the policy rate to reach 4.00% at the end of 2020. While the significant widening of the negative output gap support Banxico continuing its easing cycle, a still cautious Board over the inflation outlook and its risks, reflected in higher inflation projections for 2020, means that cuts larger than 50-bps are unlikely. However, a benign inflation scenario for 2021 supports Banxico continuing cutting rates. 

 

Joao Pedro Resende
Julio Ruiz
 



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