Itaú BBA - MEXICO – Central Bank hikes rates as the inflation outlook deteriorates

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MEXICO – Central Bank hikes rates as the inflation outlook deteriorates

Maio 18, 2017

We expect the next hike in June, in lockstep with the Fed.

The Central Bank of Mexico hiked the reference by 25-bps (to 6.75%), in line with our call and surprising the market (only 13 out of 32 analysts, as per Bloomberg, expected the hike). In its last meeting, held in March, Banxico’s board decided to smooth the pace of monetary tightening by hiking 25-bps, departing from the last six policy moves (50-bps). Moreover, the Quarterly Inflation Report – published in the preceding week – signaled that policymakers were more mindful about the potential costs imposed on economic activity. Since then, however, inflation has accelerated and activity has surprised to the upside. Headline Inflation increased to 5.8% in April (from 5.4% in March), and the behavior of diffusion indexes (73% of items in the CPI basket showing inflation higher or equal than 4%) and service inflation provide evidence that second-round effects are materializing. This deterioration of inflation conditions, in our view, was the main reason that led Banxico to hike rates in May, considering that the board has pledged to prevent second-round effects.

The statement features some relevant changes; mainly, a more hawkish tone on inflation. board now states that inflation will be “considerably” above the tolerance range around the Central Bank’s target in 2017 (rather than just above), and that the balance of risks for inflation has deteriorated. Moreover, when referring to the risks of second-round effects, May’s statement features a new sentence which reads that inflation expectations could increase as a consequence of the current behavior of inflation. Nevertheless, the board re-affirmed its view that, “until this moment”, second-round effects have not materialized. On the activity front, the statement mentions that the economy did not slow down in 1Q17 (the GDP flash estimate came in at 2.7% year-over-year, above expectations), and that the probability for the materialization of downside risks has decreased.

We expect Banxico to deliver two more 25-bp hikes, in June and September, in lockstep with the Fed; and then stay put for the rest of year, as we believe that inflation will start trending down in September. Looking forward, according to May’s statement, Banxico remains focused on the same factors as before: second-round effects from the shocks affecting domestic prices (MXN depreciation and gasoline price spike), the relative monetary policy stance between Mexico and the U.S., and the output gap. In 2018, we expect Banxico to ease monetary policy a bit; bringing the reference rate to 6.75%, as the inflation shocks dissipate and the economy expands at a moderate pace.


Alexander Müller 



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