Itaú BBA - MEXICO – 1Q19 Inflation Report: higher inflation forecasts despite lower growth

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MEXICO – 1Q19 Inflation Report: higher inflation forecasts despite lower growth

mayo 29, 2019

The balance of risks for inflation is titled to the upside

The Central Bank of Mexico (Banxico) published its quarterly inflation report for 1Q19, increasing inflation forecasts for 2019 and 2020. The quarterly average annual headline inflation forecasts for 4Q19 and 4Q20 increased to 3.7% (from 3.4% in the last report) and 3.0% (from 2.7%), respectively, while the quarterly average annual core inflation forecast for 4Q19 and 4Q20 increased to 3.4% (from 3.2%) and 3.0% (from 2.7%). According to the report, changes in inflation forecasts were mainly due to an increase in energy prices and the recent increases in core services prices. The forecast increases are considered transitory by Banxico (inflation is expected to converge to the target by 3Q20). 

As in the statement announcing the most recent monetary policy decision, the balance of risks for inflation is titled to the upside. The Board is still worried about persistence in core inflation, in addition of internal and external factors pressuring the exchange rate (and in turn inflation), the effect of the minimum wage hike in overall wage revisions and a deterioration of public finances. The report didn’t mention the new upside risk included in the most recent statement: that the greater slack in the economy doesn’t translate into lesser inflationary pressures. 

The Core inflation persistence, associated mainly to core services, remains one of the main upside risks for inflation, which is emphasized with a special analysis in the report. The analysis identifies the main drivers of the persistence of core services inflation (despite greater slack in the economy), which are an increase of energy prices and nominal wages (associated to the recent hike in the minimum wage). 

The GDP forecast range was lowered for 2019, while the balance of risk for economic activity remains tilted to the downside. The GDP forecast range for 2019 was lowered to 0.8-1.8% (from 1.1-2.1% in the last report), while for 2020 it remained unchanged at 1.7-2.7%. According to the report, the adjustment reflects the weak economic activity in 1Q19 associated to one-off factors. 

We expect Banxico to deliver two 25-bp rate cuts in the last quarter of 2019. Rate cuts in the short term are unlikely, given that the board still views the balance of risks for inflation tilted to the upside. Looking forward, we believe that with inflation falling within the central bank’s target range, below-potential growth, and a looser monetary-policy stance by the Fed, the central bank will have room to start a gradual normalization cycle, as long as uncertainty abates and risks for inflation fall.

Julio Ruiz

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