Banxico to hike the reference rate by 50bps
Banxico’s monetary policy decision (February 10th). On Thursday, Banco de México will carry out its first meeting of the year, in which we expect a 50bps hike, taking the reference rate to 6.00%. This will be a particularly interesting decision, as it will be the first one for the new Governor, Victoria Rodríguez. Our call for another hike of this magnitude is based on several factors, including: (1) An additional move higher in annual core inflation, despite a moderation in the headline; (2) a more hawkish tone from the Fed in its latest policy decision; and (3) the need to maintain a prudent stance. As such, a hawkish bias will likely prevail, even with the near certainty of a split decision happening once again
Inflation (January). We anticipate headline inflation at 0.56% m/m, recalling that the period is characterized by several seasonal factors related with start-of-the-year price adjustments and updated taxes, among others. This would have affected mainly goods at the core, On the other hand, we see more mixed dynamics at the non-core. With this, annual inflation would moderate for second month in a row, helped by a base effect and reaching 7.04% y/y (previous: 7.36%). Nevertheless, the core would accelerate to 6.18% from 5.94%, which remains concerning
Proceeding in chronological order...
Core inflation likely stayed high in January. We anticipate headline inflation at 0.56% m/m (previous: 0.36%), recalling that the period is characterized by several seasonal factors related with start-of-the-year price adjustments and updated taxes, among others, as already seen in the first fortnight. In this backdrop, some trends could extend to the second half, mainly pressures at the core (centered on goods), with a more mixed dynamic at the non-core. We anticipate them at 0.59% (contribution: +44bps) and 0.48% (+12bps), respectively. With this, annual inflation would moderate for second month in a row, helped by a base effect and reaching 7.04% y/y (previous: 7.36%). The non-core would show similar dynamics, at 9.64% (previous: 11.74%). Nevertheless, the core would accelerate further, to 6.18% from 5.94%, which remains concerning.
In the latter, goods would increase more, at 0.9% (+38bps), reflecting the price increases at the start of the year mentioned above. Processed foods would contribute the most (+1.3%; +26bps), skewed by excise tax adjustments in some of them, as well as cost pressures in several categories. Other goods would be more modest (0.6%, +11bps), in part helped by the elimination of value-added taxes in female hygiene products. Services are expected to be more mixed, at 0.2% (+6bps). Although touristic categories fell because of the end of the holiday season (despite a slight uptick in the second half), ‘others’ would compensate and take this subdivision to 0.0% (+1bp). We estimate education up 0.6% (+2bps) on higher tuitions in high school and college. Lastly, housing would increase 0.2% (+4bps), relatively in line with its historical trend.
At the non-core, we highlight a renewed increase in LP gas during the second fortnight after a strong accumulated fall since November. Nevertheless, for the full month, it would be at -1.2%. Low-grade gasoline would have risen to 1.7%, with both goods affected by higher international prices and a modest depreciation of the MXN in the period. As a result, energy prices would stand at 0.9%. On the contrary, we see a more favorable performance in agricultural goods, especially in fruits and vegetables (-2.3%). Despite strong pressures during the first half in goods such as lemon and potatoes, our monitoring suggests a stabilization. In addition, we observed a further move down in tomatoes and relevant declines in husk tomatoes and lettuce. In contrast, meat and egg (+1.8%) should rise more due to chicken and beef.
Weekly international reserves report. Last week, net international reserves decreased by US$412 million, closing at US$201.6 billion. According to Banxico’s report, this was mainly explained by a negative valuation effect in institutional assets. Year-to-date, the central bank’s international reserves have fallen by US$816 million.
Banxico to hike 50bps to 6.00% as the outlook for inflation remains quite challenging. On Thursday, Banco de México will carry out its first meeting of the year, in which we expect a 50bps hike, taking the reference rate to 6.00%. This is now the consensus view, with 12 out of 13 economists surveyed by Bloomberg (including us) believing so. This will also be a particularly interesting decision, as it will be the first one for the new Governor, Victoria Rodríguez. Our call for another hike of this magnitude is based on several factors, including: (1) An additional move higher in annual core inflation, despite a moderation in the headline (see section above); (2) a more hawkish tone from the Fed in its latest policy decision; and (3) the need to maintain a prudent stance. As such, a hawkish bias will likely prevail, even with the near certainty of a split decision happening once again.
On inflation, the 1H-January was quite telling to us about prevailing dynamics, especially the upward surprise at the core. Since early 2021, only one print has been lower relative to expectations (see chart below on the left). Although mainly driven by goods –likely on cost pressures, among other factors–, services have been trending up recently (chart below, middle). In our view, this remains as the main challenge for the Board. In theory, policy actions should have more influence at the core component. Hence, these trends likely signal that more tightening is necessary, especially on potentially more supply issues because of ‘Omicron’. Meanwhile, the non-core has been more benign in recent months, mostly fresh fruits and energy –LP gas– (chart below, right). On top of a more favorable base effect, this has contributed to the moderation in annual headline inflation since late November. However, we think the outlook for energy prices has turned more adverse, partly fueled by rising geopolitical tensions.
On inflation forecasts, the average for the headline in 4Q21 was 7.0%, lower than the 7.1% expected by the central bank. The core was in line at 5.6%. Considering this, revisions might be more modest than in previous decisions. Nevertheless, these could still be higher as we believe overall risks remain skewed to the upside. All in all, these updates, as well as the view on the balance of risks, will be important to assess the possible magnitude of rate hikes going forward.
The second key point in our view is the relative monetary stance. In its latest decision, the Fed showed a more hawkish stance, with the possibility of more hikes throughout the year. This was a key factor behind our forecast adjustment, now expecting five 25bps hikes. It also comes on top of speculation about the balance sheet run-off, which implies additional tightening. In addition, the hiking wave has continued in EMs. So far this year, we highlight Brazil (+150bps), Chile (+150bps), Colombia (+100bps), Peru (+50bps), Poland (+50bps), South Korea (+25bps), South Africa (+25bps) and Ukraine (+100bps), to name a few. In AEs, the BoE lifted by +25bps this week, as well as Norway and New Zealand late last year. In this backdrop, the MXN has been relatively stable since the last decision and even appreciated slightly until mid-January, albeit depreciating since and reaching an intra-day high of 20.91 on January 28th. In fixed income, we saw broad pressures in nominal- and real-rates with a flattening bias, albeit with a slight decline in the spreads to Treasuries. As such, we believe these factors still support the need to maintain a predictable hiking path.
Signals on economic activity have been negative, a situation that may bolster the doves’ arguments. This is especially true after the second sequential contraction in GDP as of 4Q21. Risks have also risen at the turn of the year due to the ‘Omicron’ variant, among other factors. However, we believe concerns on inflation and monetary policy from abroad will have more weight on most members.
Given all of the above, we highlight comments made by some Board members. Since she assumed her role as Governor, we have not had any public comments from Victoria Rodríguez. Hence, any assessment about her policy bias is highly uncertain. Moreover, we also have not found any comments since last meeting from either Galia Borja or Irene Espinosa. In contrast, we have had some key opinions from the remaining members. Gerardo Esquivel has mainly talked about inflation in his Twitter account, stating that a high for annual inflation in this cycle was already reached in November, expecting a downward trend ahead. This is consistent with his view in the previous minutes, maintaining a more dovish bias. Meanwhile, Jonathan Heath was a distinguished guest in our podcast Norte Económico (available only in Spanish). For inflation in 2021, he mentioned that “…we went from a process of rearrangement in relative prices to a generalized and sustained increase in prices, which is precisely the definition of inflation…”.
This illustrates our view that he has been increasingly uncomfortable with price dynamics, becoming one of the most hawkish members. We believe he shares our concerns about the core, stating that “… we clearly see an upward trend in all of its components…”. He added that they (the central bank) expects it to reach a peak in late February or early March, taking a downward trend at a slow pace afterwards. On monetary policy, he stated that “…in the short-term, we have to send a resounding message, a message that we are going through a very difficult inflationary process […] because we have to ensure that inflation expectations, especially in the medium- and long-term, are not affected…”. In our view, he will remain as one of the main proponents of a 50bps hike in this meeting, despite also recognizing that the debate is likely to be whether to increase the rate by this magnitude or only by 25bps.
Following this decision, we expect the tightening cycle to continue. Given the latest developments, we have recalibrated our forecast, now expecting five more hikes of 25bps each in March, May, June, September, and December. This would follow adjustments in the same magnitude by the Fed. As such, the reference rate would close 2022 at 7.25%, an accumulated increase of 175bps relative to YE21.
Industry to rebound with some strength in December. We expect a 1.6% y/y increase, in line with November’s print. This would happen despite a more challenging base, suggesting additional dynamism. However, it would still be below the 2.7% implied in preliminary GDP figures. There was one additional working day in the annual comparison, resulting in a 1.2% y/y expansion with seasonally adjusted figures. As a result, our forecast is more favorable than the 0.4% suggested by INEGI’s Timely Indicator of Economic Activity. Last, but certainly not least, this translates into 0.5% m/m, quite vigorous after a modest result in the previous month.
We expect a relevant acceleration in manufacturing, up 0.8% m/m (1.8% y/y). Most signals are positive, including IMEF’s PMIs (despite a moderation in ‘production’ and ‘new orders’). The trade balance showed marked strength in ‘other’ manufacturing exports and additional dynamism in non-oil intermediate goods imports. Nevertheless, we remain wary because of possible distortions due to higher prices. While there was a decline in auto exports, it seems to respond to a base effect, with AMIA’s figures pointing to a sequential 10% m/m rise in vehicles produced (using an in-house seasonal adjustment model). On the external front, data from the US is somewhat negative at -0.3% m/m, although following a 0.6% increase in November. Lastly, according to INEGI’s employment report, jobs in the sector declined by 22.2 thousand, albeit likely driven by a seasonal effect, thus not as negative as it seems.
Construction would rebound 0.6% m/m (2.3% y/y) after weakness in the past three months, with an accumulated decline of 3.6%. Both business confidence and the aggregate trend indicator improved in the past couple of months –even with an increase in the latter up to January–, so we believe that activity might catch-up to a certain degree. However, dynamism could remain limited by prevailing price pressures, with some reports pointing to a stoppage or cancelation of some works.
Meanwhile, data from federal government spending decelerated substantially to -8.3% y/y in real terms, although remembering that year-end figures tend to be skewed due to different accounting practices. In addition, employment in the sector improved substantially, rising by 268.1 thousand positions according to INEGI.
Mining would backtrack by 0.4% m/m (1.1% y/y) after recent gains. The drag would mainly come from the oil sector, as suggested by output figures. According to CNH, crude oil production inched lower to 1,650kbpd (previous: 1,653kbpd), while natural gas was even lower. On the contrary, the non-oil sector might be stronger, as suggested by higher prices and a mild rebound of exports, albeit not enough to compensate for overall weakness.
