Itaú BBA - MEXICO – 2Q18 Inflation Report: Inflation forecasts increased, while GDP forecasts decreased.

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MEXICO – 2Q18 Inflation Report: Inflation forecasts increased, while GDP forecasts decreased.

August 29, 2018

Inflation balance of risks tilted to the upside

The Central Bank of Mexico (Banxico) published the quarterly inflation report for the 2Q18, reaffirming its commitment to maintain a “prudent approach” but without a fundamental change in the guidance provided in the statement of the most recent monetary policy decision. The board will continue focusing on inflation with respect to the expected trajectory (“inflation forecast targeting”), monitoring three main variables: (1) exchange rate pass-through, (2) interest rate differential with U.S., (3) and output gap, in that order of importance. Also, the report reinforces that - amid higher-than-expected non-core prices - the board is closely monitoring the evolution of the core index.

Banxico’s official inflation forecasts increased as a result of non-core inflation behavior (due to transitory factors) and the  balance of risks for inflation is tilted to the upside. Headline inflation forecast published in the report are 4.2% (from 3.8%) and 3.3% (from 3.1%) for the 4Q18 and 4Q19, respectively. In contrast, Banxico expects core inflation to continue to descend reflecting slower growth and the monetary policy stance: 3.5% (from 3.4%) and 2.9% (from 3.0%) for the 4Q18 and 4Q19, respectively. Banxico highlighted as downside risks to inflation, an appreciation of the currency in case NAFTA understanding is favorable. As upside risks, Banxico considered higher external interest rates; additional higher energy and agro prices; protectionism measures at the global level; that higher public expenditure affects the core inflation path and if salary negotiations are not in line with productivity increases could pressure economy’s costs.

Also, GDP growth forecasts decreased due to the weakness in economic activity in the 2Q18, while mentioning an overall balance of risk to economic activity tilted to the downside. Economic activity  forecasts decreased to 2.0-2.6% (from 2.0-3.0%) and 1.8-2.8% (from 2.2-3.2%) for 2018 and 2019, respectively. The report mentions as upside risks to economic activity forecasts, that NAFTA agreement of understanding reactivates investment and higher U.S. industrial production and higher public expenditure than anticipated. As downside risks, the report mentions an increase of global protectionism measures; volatility in international markets and that uncertainty that has been affecting investment remains. 

In our view, a successful renegotiation of NAFTA would likely mean an end to the tightening cycle. Last Monday, President Trump announced a trade deal (agreement of understanding) with Mexico. However, we consider that the inclusion of Canada (or not) in the deal reached last Monday could still affect the Mexican peso and thus the next monetary decision. 

Julio Ruiz

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