Itaú BBA - MEXICO – Central Bank minutes reveal concern over higher exchange-rate pass-through; Governor Carst

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MEXICO – Central Bank minutes reveal concern over higher exchange-rate pass-through; Governor Carst

December 1, 2016

Governor Carstens’ resignation doesn’t affect the governance nor the credibility of Mexico’s monetary policy

The Central Bank of Mexico published the minutes of its November monetary policy meeting, in which the Board decided to increase the policy rate by 50 bps (one week after Trump’s election), indicating that the decision was unanimous. All board members agreed that the balance of risks on both inflation and economic activity have deteriorated, with respect to the previous meeting (before the U.S. election). Exchange-rate depreciation was mentioned as the main threat to the inflation outlook, while the uncertainty over U.S. policies is at the top of the list of risks for activity. At the outset, we were expecting little new information from November’s minutes, considering that the recent Inflation Report (and its press conference) already discussed Banxico’s actions in detail. However, in our view, the minutes reveal two important new pieces of information.

First, the majority of board members believe that the likelihood of higher exchange-rate pass-through – that is, a higher coefficient – has increased. Currently, Banxico’s official estimate of the pass-through coefficient is 4% (see page 48 of the Inflation Report published in May 2016), which is quite low compared with other Latin American inflation-targeting countries (Brazil, Chile, Colombia and Peru). In the minutes, the board argues that the permanent nature of the recent shock and that little slack in the economy could translate into a higher exchange-rate pass-through. We believe that this is important because Banxico will probably need to calibrate monetary tightening if the abovementioned coefficient is higher.

Second, one board member highlighted that, under current conditions, Banxico has little room to decouple from the U.S. Fed. In fact, he argued that an increase of the federal funds rate would carry risks for inflation and financial stability if Banxico adopts a “passive attitude”. This is in line with our forecast that, at least for the rest of 2016 and 2017, Banxico will hike in lockstep with the Fed.

We expect Banxico to hike by 25 bps in December, assuming the Fed makes a similar move, and then deliver two similar hikes next year (also in lockstep with the Fed), bringing the reference rate to 5.5% and 6.0% by the end of 2016 and 207, respectively. Basically, the official view of Banxico is that Mexico is facing a real shock (rather than just volatility), which is why they are more tolerant of exchange-rate depreciation (so the economy can accommodate the shock). The focus is now on exchange-rate pass-through to domestic prices, with the priority being to prevent second-round effects.

Finally, on another note, we believe that Governor Carstens’ recent resignation doesn’t affect the  governance nor the credibility of Mexico’s monetary policy.  Today, there were news that Agustín Carstens presented a resignation letter to President Peña Nieto, and will step down from the Central Bank Governor position in July 2017. Thus, Banxico's board will experience some re-shuffle in 2017. Manuel Sánchez (one of the four deputy governors) will leave the board at the beginning of 2017, and has been replaced by Alejandro Díaz de León (CEO of Mexico's Foreign Trade Bank and former Chief Economist at Banxico). Díaz de León was appointed by President Peña Nieto, and confirmed by the Senate yesterday. The successor of Carstens will likely be another technocrat with strong academic and professional credentials – just like every other member of the board – so we don't think there is a negative implication on the conduction of Mexico's monetary policy. Banxico has built a strong credibility over the past decades, which is reflected in the taming of inflation (significantly down from the 90s decade levels), well-anchored inflation expectations, and low exchange rate pass-through. The inflation mandate ensures discipline, and we believe that the quality of governance at Mexico’s Central Bank is high.     


Alexander Muller



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