Macro Analysis /
Global

Mexico: Ahead of the Curve

  • We expect a 50bps hike from Banxico, taking the rate to 7.00%, pressured by the Fed and local inflation conditions

  • We estimate April’s CPI at 0.57% m/m. The core would remain pressured (0.79%), with seasonality in the non-core (-0.05%)

  • Other indicators to be released include March’s industrial production, April’s ANTAD sales and wage negotiations

Juan Carlos Alderete Macal
Juan Carlos Alderete Macal

Director of Economic Research

Francisco Jose Flores Serrano
Francisco Jose Flores Serrano

Senior Economist, Mexico

Banorte
6 May 2022
Published by

Banxico to keep tightening monetary conditions by 50bps in May

  • Banxico’s monetary policy decision (May 12th). We forecast a 50bps hike in the reference rate to 7.00%. This matches consensus, with all economists surveyed by Bloomberg expecting the same (14 analysts). We believe that conditions for a tightening of this magnitude are clear, highlighting: (1) An increase of the same magnitude by the Fed last Wednesday; (2) volatility in financial markets, including in the MXN; and, last but not least, (3) persistence of inflationary pressures, especially in food items. As such, we expect the tone to remain hawkish, in what will likely be a unanimous decision for a second straight meeting

  • Inflation (April). We anticipate headline inflation at 0.57% m/m (previous 0.99%). The core would climb to 0.79% (contribution: +58bps), with the non-core down 0.05% (-1bps). We must remember that the period is benefited by the start of summer discounts in electricity tariffs, a situation already observed in the first half. However, it would be relatively higher than previous years considering: (1) Additional pressures in goods, particularly processed foods; (2) a modest move up in the rest of energy; and (3) an uptick in agricultural items. If our estimate materializes, inflation will increase to 7.71% from 7.45% on average in March, with three consecutive months on the upside and reaching a new high since January 2001. The core would stand at 7.22% (previous: 6.78%), with the non-core moderating to 9.16% (previous: 9.45%)

Proceeding in chronological order...

April’s inflation to remain on the upside, albeit with a moderation in the second half. We anticipate headline inflation at 0.57% m/m (previous 0.99%). The core would climb to 0.79% (contribution: +58bps), with the non-core down 0.05% (-1bps). We must remember that the period is benefited by the start of summer discounts in electricity tariffs, a situation already observed in the first half. However, it would be relatively higher than previous years considering: (1) Additional pressures in goods, particularly processed foods; (2) a modest move up in the rest of energy; and (3) an uptick in agricultural items. If our estimate materializes, inflation will increase to 7.71% from 7.45% on average in March, with three consecutive months on the upside and reaching a new high since January 2001. The core would stand at 7.22% (previous: 6.78%), with the non-core moderating to 9.16% (previous: 9.45%).

Back to monthly dynamics, within the non-core, energy would fall 1.4% (-15bps), dragged by electricity tariffs (-12.3%; -25bps). In the remaining categories, we see LP gas lower for a second straight fortnight. However, given the arithmetic effect of the increase in the 2nd half of April, the monthly comparison would be at +0.9% (+2bps). Low-grade gasoline would keep rising (1.4%; +7bps), with a renewed boost from higher international prices in recent weeks. In agriculture (+1.1%: +13bps), we anticipate more modest growth in the second fortnight. In this sense, meat and egg would climb to 0.4% 2w/2w from 0.87% in the first half, resulting in +1.7% in the full month. Fruits and vegetables would even turn negative, with our monitoring showing a decline in tomatoes, lemons, and onions, giving a monthly result of 0.5% (+2pbs).

The core would remain pushed by goods (0.5%; +40bps). Similar to some non-core categories, we estimate a moderation at the margin. Specifically, we anticipate +1.2% (+26bps) in processed goods. Inside, corn tortilla prices would have maintained their upward trend, along with milk and its derivatives. On ‘other goods’ (+0.8%, +14bps), we believe cost pressures lingered, highlighting autos, albeit also with a moderation in some electronics and appliances. On services (0.1%; +18bps), pressures would ease, with tourism-related items benefiting from the end of the Easter holiday. However, the monthly metric for ‘other services’ would stay positive at 0.9% (+15bps) on two factors: (1) The increase in said items in the first fortnight; and (2) additional pressures in the rest of the categories, having to continually adjust prices due to rising costs. Finally, housing should remain modest, at 0.1% (+3bps).

Weekly international reserves report. Last week, net international reserves decreased by US$330 million, closing at US$199.2 billion. According to Banxico’s report, this was explained by a negative valuation effect in institutional assets. Year-to-date, the central bank’s international reserves have fallen by US$3.2 billion.

Industry likely failed to gather pace in March. We expect IP at 2.1% y/y. This is virtually in line with the implied performance in the preliminary GDP for 1Q22. Based on our calculations, it is consistent with +1.9% y/y seasonally adjusted. The latter is much lower than INEGI’s estimate in the Timely Indicator of Economic Activity, at 3.1%. Sequentially, this would result in a -0.1% m/m, low considering the 1.1% decline seen in February.

We see construction at 0.6% m/m (-2.4% y/y). Although positive, it would not be enough to reverse the latest contraction of 1.5%. We continue seeing muted dynamics in the private sector, in our view most closely related to edification. In this sense, the sector’s business confidence indicators fell across the board. Nevertheless, data is mixed. The aggregate trend indicator and COVID-19 dynamics improved. In our view, exchange rate weakness in the period –which may have pressured costs of imported raw materials even more– amid surging uncertainty because of the war in Ukraine (with the invasion starting on February 28th), among other factors, likely had a more significant impact. On the contrary, works probably accelerated in the public sector, especially ahead of the official inauguration of the Felipe Angeles Airport on March 21st. Given a less challenging base effect, civil engineering could have outperformed.

In manufacturing, we expect a deceleration at the margin, to 0.2% m/m (+4.5% y/y). On known data so far, we highlight that auto production was stronger relative to February in absolute terms (305,976 units) as well as in the annual comparison, at 0.8%. Meanwhile, employment also increased in INEGI’s report, with 157.8 thousand new jobs in this sector. Although this may have been driven by seasonal factors, our calculations suggest gains after adjusting for this. Other figures supporting this include sequential growth of +0.9% m/m in US manufacturing and IMEF’s PMI manufacturing picking up, including in ‘new orders’ and ‘production’. In contrast, manufacturing exports fell 3.9% m/m, which makes us cautious. Nonetheless, we fade this out to some extent on very high volatility in recent data, which we think is related to supply chain problems, reflected in very meaningful variations in inventories.  

Lastly, we expect mining at -0.2% m/m (-0.5% y/y). Although this would be on top of February’s -6.6%, we see the latter mostly as ‘payback’ from January’s +6.4%. Our call rests mainly on oil production data from the National Hydrocarbons Commission, at 1,625kbpd. This corresponds to a 4.3% y/y drop from -2.0% in February. On the other hand, it may be partially compensated by gas, with better production at the margin. We anticipate non-oil mining to have stayed resilient, supported by high commodity prices, while related services also rebounding after an unusual plunge of 43.8% m/m of the previous month.

If we are right, these results would signal a weak start of the second quarter. In this sense, trade disruptions related to new COVID-19 lockdowns in China are not likely to have shown up in this report. The latest outbreak began near the end of February, but lockdowns in the port-city of Shanghai started until March 28th, with the measures encompassing the entire city until April 5th. Logistics issues –especially in maritime transportation– worsened from that date forward, affecting global supply chains once again. 

Banxico to continue with 50bps hikes in May, pressured by the Fed and inflation conditions. We forecast a 50bps hike in the reference rate to 7.00%. This matches consensus, with all economists surveyed by Bloomberg expecting the same (14 analysts). We believe that conditions for a tightening of this magnitude are clear, highlighting: (1) An increase of the same magnitude by the Fed last Wednesday; (2) volatility in financial markets, including in the MXN; and, last but not least, (3) persistence of inflationary pressures, especially in food items. As such, we expect the tone to remain hawkish, in what will likely be a unanimous decision for a second straight meeting.

In line with expectations, the Federal Reserve in the US increased the Fed funds range by 50bps, on top of announcing the beginning of the reduction of its balance sheet and maintaining a hawkish tone regarding inflation. Considering the importance and consequences of the tightening process in said country, on top of the strong links that exist in economic terms and the relative monetary stance between Mexico and the US, we believe this cues Banxico to increase its reference rate in at least this magnitude. We must also add the restrictive wave since the previous decision in both emerging and advanced economies, resulting in additional pressures for interest rates. Related to this, since March 24th, the Mbonos curve has been pressured by about 50bps on average with a slight steepening, with tenors from 10 years onwards up by 60bps. Rates in inflation-linked Udibonos have also increased, although more defensive in longer terms. Meanwhile, holdings of government bonds by foreigners have continued to decrease, even at a faster pace since the last decision. In this context, the exchange rate been very volatile despite also exhibiting defensiveness relative to peers in an environment of USD gains. The view that Banxico will continue with the tightening cycle has likely helped anchor the currency, which is also important for inflation expectations.

In particular, the currency has an accumulated depreciation of 0.3% to 20.14 per dollar in this period, with a range between 19.79 and 20.47 per dollar. We consider that the relative performance reaffirms the need to maintain a cautious stance, which has characterized Banxico for a while.

On prices, annual inflation –both headline and core– kept increasing in the 1st half of April, which we expect to extend to the second half of the month (see section above). Latest figures showed a moderation in some energy items, consistent with dynamics in international references (chart below, left), although with signs of a recent rebound. Nevertheless, food –both processed and fresh (chart below, right)– maintain a concerning trend. We believe this has been influenced by passthrough from cost increases (both in raw materials and energy). In this backdrop, the government presented a plan to combat inflation, centered in 24 basic goods, with 22 belonging to these categories. However, considering the nature of these actions and that it is still too early to measure their potential impact, the central banks will have to continue with the restriction to continue fighting this problem in coming months. 

In this context, we expect inflation forecasts from the central bank to be revised higher once again, especially for 2022. For example, Banxico’s headline and core inflation estimates for 2Q22 stand at 6.9% and 6.7% y/y on average, respectively. Both are 60bps lower than our estimates of 7.5% and 7.3%, in the same order. Given recent dynamics and new price shocks, we find it very unlikely that these estimates are achieved. We believe forecasts for at least the next four quarters will be adjusted higher. A key issue will be if the estimated moment of convergence to target (currently in 1Q24) is delayed even further. On the balance of risks, we think it will remain skewed to the upside, even with an additional deterioration.

Regarding economic activity, they will highlight the 0.9% q/q expansion in 1Q22 GDP. However, risks will remain skewed to the downside amid a more challenging backdrop, which will likely impact dynamism in the second quarter. They will reaffirm that slack conditions will remain for a prolonged period.

Lastly, among members’ comments, we highlight the appearance of Governor Victoria Rodríguez in the Senate, as well as opinions from Deputy Governor Jonathan Heath on Twitter this week. The Governor’s message was very much aligned with the Board’s consensus, as we have perceived in latest publications. We highlight her comments son the importance of the relative monetary stance with the US, mentioning that they expect that “…interest rates will have consecutive increases in the remainder of the year, and in addition, said increases will likely be higher and faster that what had been anticipated, which implies an additional challenge for the conduction of monetary policy in our country…”. This is consistent with reasons to maintain prudence, which favors an orderly behavior of financial variables –such as the exchange rate– and capital flows. Regarding prices, she affirmed that “…we consider as a priority that there is a general consensus in society regarding the importance of the convergence of inflation to our goal of 3% and that the vision of high costs of inflation on incomes and total wealth of the population is shared…”. We think this reinforces the clear commitment with the central bank’s mandate. Deputy Governor Heath spoke about the federal program to fight inflation that we have already mentioned, stating that “…I don’t have issues thinking ‘outside of the box’ in terms of looking for policies that help us counteract inflation…”, although he also added that “…price controls only work in the short-term, so we have to be very careful in terms of their instrumentation…”. It is important to note that these comments were made before the announcement. Especially, given that it is our take that the measures do not aim for price controls, which will probably be positive for Heath –and other members–. Therefore, although the central bank could take this as a positive sign, it will keep acting to fight this problem.

We believe all these factors will support a more hawkish tone and actions from the central bank, supporting our call that the restrictive cycle will continue for the remainder of the year and into 2023.