Mexico's central bank raises its forecasts despite prevailing uncertainty

  • Banxico published its 3Q20 Quarterly Report; followed by a conference by Governor Alejandro Díaz de León
  • Forecasts for both inflation and growth were revised higher, with uncertainty weighing heavily on the outlook
  • Despite valuable data on the document, especially on inflation, we await more information from the minutes tomorrow

Banxico published its 3Q20 Quarterly Report (QR) on Wednesday. The release was accompanied by a press conference by Governor Alejandro Díaz de León. 

Overall, we believe the document confirmed the neutral stance we saw in the statement, consistent with the pause the monetary authority wants to take in its easing cycle. 

On inflation, the central bank delivered on expectations and revised its forecast upwards for most of the trajectory, taking the explicit convergence towards the 3% out of the forecast horizon. 

Moreover, the balance of risks for inflation remains uncertain, although with changes in specific factors, highlighting:

  1. The increase to five from three in the number of drivers in the statement;

  2. More changes in those to the downside, emphasizing the effects on prices from El Buen Fin (Mexico’s Black Friday); and

  3. Concerns about rising energy prices, which could materialize in case of a more vigorous economic rebound 

On growth, Banxico eliminated its scenarios, favoring again a central forecast. This represented a relevant revision for 2020, to -8.9% y/y from a simple average of -11.0% previously. For 2021, the adjustment was more modest, at 3.3% from 3.2%. 

The traditional grey boxes expanded on the effects of the pandemic –especially on prices–, policy actions and recent market dynamics. 

Banxico also published the calendar for its policy decisions in 2021, again broadly aligned to the Fed. 

Despite valuable data in the document, especially on inflation, we await more information from the minutes tomorrow to evaluate the moment and magnitude of cuts once the easing cycle resumes.

The Quarterly Report maintains a neutral tone, as in the last statement. Banxico published today its Quarterly Report (QR) for 3Q20. The release was accompanied by a press conference led by Governor Alejandro Díaz de León. In line with hints by the institution, the inflation forecast was revised mostly to the upside, without clarity about the convergence of the headline to the 3% target in the forecast horizon. Meanwhile, growth was consolidated into one scenario, with an important upward revision for 2020 and more modest into 2021, on top of introducing the estimate for 2022. Overall, the document confirmed the importance of the central bank’s ‘data-dependency’, especially because of prevailing uncertainty on inflation forecasts due to the pandemic, even with hopes of a vaccine and a better-than-expected rebound in economic activity. 

Revisions to inflation reflect central bank concerns. As anticipated in the last statement, the monetary authority revised its inflation forecasts mostly to the upside. Nevertheless, considering recent developments, the estimate for 4Q20 was cut 10bps, from 3.7% to 3.6% on average. During the press conference, Governor Díaz de León mentioned that discounts in El Buen Fin (Mexico’s Black Friday) drove a large part of the decline in prices in the first half of November (which surprised the market and us strongly to the downside). In our view, it is very important that the Governor said this factor was considered transitory within their forecast path, suggesting a reversal higher relatively soon. Despite this assumption, he also warned that they will have to check if discounts are extended or not. In this sense, this downside risk was important enough to be added to the balance of risks, over which we expand further below.

Headline inflation does not reach exactly 3% in the forecast horizon… In the upward revisions, we saw adjustments between 10 to 40bps in four out of the five quarters starting in 2Q21. We were relatively concerned about the adjustments in 4Q21 and 1Q22 (see table below). Although these respond in part to a more challenging base effect, it is not the only factor. Among them, Banxico expects a larger upside from rising energy prices and a greater persistence of core prices (given a marginally lesser degree of slack). Hence, there is no convergence to 3% in headline inflation during the forecast horizon (at least in these numbers). Regarding this, the Governor highlighted that adding the ‘pause’ in the statement will allow for a thorough evaluation of available and incoming data to corroborate if the path converges towards the target.

...while the core would reach that level in 3Q21. The forecasted path for the core was also revised higher, with five out of six quarters starting in 1Q21 adjusted between 10-30bps. Despite of the latter, the 3% level would be reached in the third quarter of next year, matching the last Quarterly Report. Here, the monetary authority details that the transitory nature of El Buen Fin would fade away despite its positive impact. Meanwhile, reduced slack relative to previous estimates would also push the index higher. We believe the trajectory of this component gained even greater relevance after it was included with more weight in the statement, with the explicit mention of when it will converge to the target.

Relevant revisions on inflation risks. The balance of risks remains characterized as uncertain (see section of grey boxes for additional details). Nevertheless, they updated the risk section, with relevant changes when compared to the statement. Specifically, the list was expanded from 3 to 5 both to the upside and downside. Risks to the downside saw more changes, highlighting: (1) Weakness in demand, with the possibility that discounts on El Buen Fin are more persistent; 82) the addition of the appreciation of the exchange rate as a driver; (3) the possibility of lower than anticipated energy prices; and (4) that wage revisions do not pressure prices given the degree of slack. In our opinion, the latter is very relevant, given accumulated minimum wage increases from previous years and the upcoming announcement for 2021, which we expect soon. Risks to the upside were more stable, with changes only in: (1) Distortions on relative prices due to changes in demand conditions; and (2) higher energy prices. We also highlight the persistence of core inflation to the upside as the main risk factor now.

In line with our expectations, the forecast for economic activity improved. Unlike the previous two reports, Banxico presented only a central estimate for GDP, not three scenarios. They now expect an 8.9% y/y contraction in 2020 (previous simple average: -11.0%), followed by a 3.3% expansion in 2021 (previous: 3.2%) and +2.6% in 2022. This assumes a gradual recovery, with caution by consumers and investors because of the pandemic. Moreover, they foresee challenges for aggregate demand, especially domestic. It should be noted that the resulting forecast for this year is very similar to what used to be the ‘V-shaped’ scenario, with a difference of only 10bps, taking into account that 3Q20 GDP was slightly higher than expected. In addition, it is slightly more optimistic relative to market expectations at -9.3% –according to the latest Banxico survey– but closer to our -9.0%.

Uncertainty over growth remains elevated. As a result, the monetary authority kept its options open, setting both an upper and lower bound, with a range for the three years. With this, the range for 2020 comes in from -9.3% to -8.7%; 2021 from 0.6% to 5.3%; and 2022 from 2.6% to 3.8%. We should mention that the interval for 2021 is much wider than in previous instances –as it used to be only of 1%-pt–. For 2022 it is more uncertain given that it is impacted by the base effect from the previous year (and with Banxico assuming inertial growth by that year). In detail, assumptions for the limits are:

(1)    Lower bound: Assumes a limited fiscal response in several countries, a worsening of the pandemic and new lockdowns between late 2020 and early 2021. Afterwards, they anticipate a moderate recovery in the latter part of this last year, with activity converging towards potential in 2022.

(2)    Upper bound: The recovery is faster, with a stronger reactivation of several economic sectors that have stayed weak. It also incorporates additional stimulus from external demand, driving activity in 2020 and 2021, while moderating the pace of the expansion towards potential in 2022.

The central bank did not mention when they expect the vaccine against COVID-19 to be available. In our opinion, this is key to forecast the pace of the recovery. In this sense, our estimate for 2021, at 4.1%, is more optimistic than the institution’s mid-point, in large part because we believe the vaccine will be ready towards the end of 2Q21 and early 3Q21. Therefore, this would provide for an acceleration in the pace of growth in the second half of next year. Considering this, the central bank maintains that the balance of risks is skewed to the downside, quoting several factors related to the pandemic (e.g. the possibility of new lockdowns, financial market volatility, important aftershocks to activity), along others of a more idiosyncratic nature (e.g. reductions to the credit rating and domestic uncertainty).

Less slack after the rebound in 3Q20, but without relevant pressures going forward. After the widening of the output gap to -20.3% in 2Q20, the recovery in the following quarter took it to -10.4%. Despite of this, it would not reach close to zero even at the upper bound, always remaining negative (see chart above, right). Therefore, demand-side pressures should not be a source of inflation, at least in the central bank’s forecast horizon.

Relevant updates in other estimates. Forecasts for employment at IMSS, trade balance and current account were also updated. In the first, the backdrop is more favorable, with a point estimate of 775 thousand jobs lost this year (previous:  -925k). This is consistent with recent dynamics and upward revisions to GDP. For 2021 they expect a creation of 325 thousand jobs. On the other hand, they see a higher trade balance surplus, with the point estimate at US$28.7 billion, reflecting more external demand strength relative to the domestic component. Next year the surplus would remain, albeit more moderate, at US$5.1 billion.

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