We believe the inflation outlook has deteriorated significantly in the past couple of weeks, leading us to revise our year-end forecast for 2022 to 6.7% y/y (previous: 4.4%)
Both core and non-core inflation would be higher, forecasting them at 6.4% and 7.6%, respectively
The main drivers behind our revision include:
(1) Higher prices of energy and other commodities, along with increased MXN volatility due to the war in Ukraine;
(2) Upside surprises at the core from prevailing supply disruptions, further cost increases, and additional changes in consumption patterns; and
(3) More difficult weather conditions that would impact crops, as well as other sectors
Some downside risks may be materializing (e.g. an improvement on virus conditions and mobility), albeit it is our take that drivers to the upside will be more persistent and stronger in magnitude, resulting in a more modest reduction in annual inflation for the rest of the year
Considering this backdrop along and a more hawkish stance by the Fed, we maintain our call for a 50bps hike by Banxico on Thursday. Moreover, we now believe this will be followed by an increase of the same magnitude in May
Following this, we expect +25bps adjustments in the five remaining decisions of the year, in line with the similar moves by the Federal Reserve, taking the reference rate to 8.25% (previous: 7.50%)
Inflation at 6.7% y/y by the end of 2022. This represents 230bps more than our previous estimate. In our view, the outlook for inflation has deteriorated significantly in the past couple of weeks, mainly (but not exclusively) because of the reverberations of the war in Ukraine across global markets. In particular, we now expect both the core and non-core higher at 6.4% (previous: 4.1%) and 7.6% (previous: 5.1%), in the same order. Most shocks still seem to be mainly originating abroad, albeit likely with a more sizable domestic impact in the price formation process given built-up cost pressures and more lasting effects.
A more challenging backdrop for inflation. Inflation dynamics have become more complex since 2020, especially at the core. This component has shown more persistent pressures and has consistently overshoot estimates (chart below, left) because of several factors, including: (1) Supply disruptions; (2) cost increases; and (3) changes in consumption patterns, among others. However, and contrary to our expectations, these have extended further into 2022, resulting in additional challenges for prices. Lastly, the war in Ukraine has triggered sharp increases across most commodities –especially energy (chart below, right)–, which we see as having both direct and indirect effects on CPI as costs pass-through to consumers. Lastly, we expect adverse weather effects to keep weighing on crops, with additional reports of distortions from an extended process of the La Niña phenomenon.
Banxico to take a more aggressive approach in its hiking cycle. We maintain our forecast that the central bank will increase the reference rate by 50bps this Thursday. However, we now forecast +50bps also in May (previous: +25bps), mainly on a more complex short-term inflation outlook –at a high of 7.6% in April– and challenging financial conditions. After this, Banxico would follow a more hawkish Fed –now forecasting 25bps hikes in each of the 6 decisions left this year– with +25bps steps in the five remaining meetings after May (June, August, September, November and December). With this, the rate would reach 8.25% by the end of 2022 (previous: 7.50%). For 2023, we still anticipate an accumulated 100bps increase, although now front-loaded to 1H23, ending the hiking cycle earlier and with a higher terminal rate of 9.25%.