Mexico: The end of the rate increase cycle is approaching - BBVA

According to the Research Department at BBVA, inflation in Mexico will continue to decline at a good pace. They see that risks to inflation continue to be biased upwards, but have moderated. 

Key Quotes: 

“We are maintaining our forecast for growth in 2018 at 2.0%, driven by private consumption that is being strengthened in a context of lower inflation, and the consolidation of exports driven by improved performance from the US industrial sector, especially manufacturing activities. In 2017 the economy grew by 2.3%, as a result of a rebound in growth in the fourth quarter to 0.8%, driven by trade and services, which showed a rapid recovery after the September earthquakes, and primary activities, which recorded greater dynamism in 4Q17. Manufacturing is beginning to show signs of recovery, after registering slow dynamism in the first three quarters of the year.”

“After the temporary increase in 4Q17, inflation has resumed its downward trend in 1Q18 as we forecast. Data for the first month-and-a-half of the year (to mid-February) clearly indicate that both headline and core inflation are moderating, and suggest that, as we anticipated, the interruption in the downward trend in inflation during 4Q17 will only be transitory. The change in trend in inflation in 1Q18 is due mainly to the gradual fading of the two main shocks to which it was exposed in 2017, namely the increase in energy prices in January and the considerable additional depreciation of the peso in reaction to the result of the US elections which led to an increase in the rate of pass-through to goods.”

“Inflation will continue to decline at a good pace; the risks to inflation continue to be biased upwards, but have moderated. We expect both headline and core inflation to continue to decline at a brisk pace throughout 2018. We anticipate that headline and core inflation will be below 5.0% and 4.0%, respectively, in April, and below 4.0% (at 3.8%) and 3.5% (at 3.3%), respectively, at the end of the year, below the upper limit of variability of the central bank target.”

“The end of the rate increase cycle is approaching. Going forward, Banxico will maintain this pre-emptive approach in the short term, but we believe that Banxico will consider increasing the monetary rate only once more and that after doing so it will feel more comfortable with inflation falling at a good pace, with anchored medium- and long-term expectations, with those at 12 months being moderated, and year-end expectations possibly decreasing marginally. In addition, the increases in rates already observed have brought the benchmark rate to a restrictive level.”

“The main risk continues to be associated with the NAFTA renegotiation process (...) Both Mexico and Canada know that a NAFTA 2.0 will not be reached without changes in the rules of origin in the automotive sector, and for the moment, the US is showing no flexibility. The risks of a collapse continue to decline, but those of prolonged negotiation have increased.”

“Mexican assets have been influenced more in recent times by the global environment than by the evolution of idiosyncratic risks. Nevertheless, these risks remain latent and it is expected that in the coming months they will explain to a greater extent the volatility of domestic financial variables, particularly as regards the electoral process. We believe that in a scenario in which the NAFTA negotiations are postponed it will be difficult for the peso to appreciate consistently and bring the dollar to levels below 18 pesos towards the end of the year. This scenario is very different from the signing of a new and favourable agreement, which could take the dollar down below 17.5 pesos. On the other hand, interest rates will maintain an upward trend, which could also be exacerbated closer to the election. In particular, the yield to maturity of the 10-year sovereign bond is expected to close 2019 at around 7.6% on average.”