Itaú BBA - MEXICO – Disinflation is gaining traction, reinforcing our call of no rate hike in April
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MEXICO – Disinflation is gaining traction, reinforcing our call of no rate hike in April

April 9, 2018

Inflation at the margin is running at low levels

Inflation continued decreasing in March, more than expected by the market, with stronger evidence that the disinflationary process is gaining traction. CPI inflation posted 0.32% month-over-month in March, closer to our forecast (0.35%) than to median market expectations (0.40%, as per Bloomberg). Notably, the inflationary pressure was largely circumscribed to a few items considering that 5 goods (gasoline, tomatoes, lemons, chickens, and tourism package services) accounted for over nine tenths of the month's CPI print. Importantly, the gap between monthly CPI inflation and 10-year median variations (proxy of normal inflation levels) has been decreasing gradually to -2bps in March from – on average – 4bps in 1Q18, 10bps in 2H17, and 23bps in 2017.    

Annual CPI inflation decreased with lower readings for both the core and non-core indexes. Headline inflation fell to 5.04% year-over-year in March (from 5.34% in February), and core inflation decreased to 4.02% (from 4.27%) during the same period. Core goods (tradables) inflation came in much lower than before (4.64%, from 5.18%) while core services (non tradables) inflation was unchanged at 3.49%. However, we note that a cleaner indicator for prices driven by domestic demand (core services excluding telecom, tourism related services, and airfares) actually posted lower inflation (3.66%, from 3.75%). Turning to the non-core index (8.03%, from 8.49%), the decrease for food (7.74%, from 9.69%) and regulated items (6.85%, from 7.08%) was partly offset by higher energy inflation (8.85%, from 8.16%). 

The diffusion index has fallen substantially, and measures of inflation at the margin (for both the CPI and the core index) have decreased to levels close to the Central Bank’s 3% target. The diffusion index, which tracks the percentage of items in the CPI basket with inflation higher or equal to four, went down to 56.7% (from 62.5% in February) reaching the lowest result in 15 months. Moreover, readings of inflation at the margin indicate that price dynamics have turned much more benign over the past months. In fact, seasonally-adjusted three-month annualized inflation has fallen across the board: CPI (3.13%, from 3.26% in February), core (3.31%, from 3.64%), core goods (3.62%, from 4.21%), and core services (3.06%, from 3.24%).

The significant decrease of inflation in 1Q18 implies that a rate hike at the Central Bank’s next meeting (April 12) is unlikely. The point is that average annual inflation came in below Banxico’s forecasts for 1Q18 (CPI 5.3% vs. 5.5%, core 4.3% vs. 4.4%) and Governor Díaz de León has been stressing that deviations with respect to these quarterly forecasts (recent innovation presented in the QIR) will be important for rate decisions. Of course, the appreciation of the Mexican peso, over more constructive NAFTA renegotiations, is another important reason for not hiking. Our base case is that inflation will decrease to 3.7% by the end of 2018 (below median market expectations of 4.1%, according to the Central Bank’s last survey). 

Alexander Müller

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