Itaú BBA - MEXICO – Central Bank Inflation Report: Buttressing the neutral stance

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MEXICO – Central Bank Inflation Report: Buttressing the neutral stance

August 30, 2017

Banxico innovates its communication framework

In its most recent inflation report, the Central Bank of Mexico increased the mid-point of its growth forecasts for this year (to 2.3%, from 2.0%) and the next (to 2.5%, from 2.2%). In spite of the more optimistic view on growth and the recent upside surprises on inflation, the central bank forecasts lower inflation in 2018 relative to the previous report, possibly due to the stronger Mexican peso. The central bank sees balanced risks to its forecasts for both growth and inflation. In the report, Banxico reaffirms that the current level of monetary policy rate (7%) is consistent with a neutral monetary policy (that is, a real ex-ante policy rate within the range considered neutral), which – added to solid growth forecasts, likely Fed rate hikes, and uncertainties associated with NAFTA renegotiation and the presidential elections – means there is no rush in reducing interest rates. Consistent with this, when presenting the report Governor Carstens stated that the central bank should be “very patient about reducing rates”, also in-line with previous commentaries by different board members in the press.  

Banxico introduced a substantial innovation in its communication framework, by publishing the expected trajectories for inflation (comparing the new forecasts with the ones featured in the previous quarterly inflation report). Previously, Banxico’s fan charts (a framework created by the Bank of England in the 90s, also called “rivers of blood”) only showed ranges for the forecasts, using colors to differentiate probabilities. During his presentation, Governor Cartstens argued that this innovation will provide more transparency and, thus, reduce uncertainty in markets. The forecasted inflation trajectory is now higher for 2017, but lower for 2018 (even slightly below the 3% target by the end of 2018). Moreover, Governor Carstens said that a number of inflation measures – such as the diffusion index which tracks the percentage of items in the CPI with inflation below or equal to 3%, seasonally-adjusted annualized variations, and the trimmed mean inflation (excluding outliers) – already show inflation stabilizing (with some components now trending down). 

We see the policy rate in Mexico at 7% at least until the beginning of the 2H18. While the central bank’s view on inflation (or at least the view of the majority of its board members) indicates that rate hikes are unlikely, we believe there is no appetite for cuts, considering the risks associated to NAFTA, elections and monetary policy in the U.S., in a context of solid growth and an interest rate within a range consistent with neutrality. 

Alexander Müller


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