Monetary Policy Implementation During US Policy Normalization. Javier Guzmán Calafell, Deputy Governor, Banco de México

Transcription

1 Javier Guzmán Calafell, Deputy Governor, Banco de México JP Morgan Investor Seminar Washington, DC, 1 October 214 1

2 Outline 1 Introduction 2 Monetary Policy in a. The External Environment b. Domestic Conditions 3 Beyond 215 2

3 Since 21, monetary policy in Mexico is implemented under an inflation targeting regime. In this context: A permanent inflation target of 3 percent, with a variability interval of +/- 1 percent, has been set. A systematic analysis of inflation and its determinants is carried out, on the basis of a wide range of indicators and tools. The efficient convergence of inflation to the target (i.e. at the lowest possible cost in terms of economic activity) is sought. It is also worth noting that in the aftermath of the global financial crisis, the Banco de México, in coordination with other authorities, is attaching increasing relevance to financial stability. 3

4 With the support of major efforts on the fiscal side, such a strategy has allowed continued progress in the reduction of inflation Headline Inflation and Overnight Interbank Interest Rate Annual % Introduction of inflation targeting Sep Overnight interbank interest rate 1/ Sep Headline inflation 2 1 Headline inflation Source: Banco de México. 1/ Target for the overnight interbank interest rate adopted on 21 January 28. 4

5 and to maintain stable medium and long term inflation expectations even in the presence of substantial shocks. 6 Inflation Expectations and Inflation Shocks Annual % Sep MXN/USD Exchange Rate Fruits and Vegetables Inflation Expectations: 12 months 2 years 4 years Sources: Banco de México and INEGI. 5

6 Outline 1 Introduction 2 Monetary Policy in a. The External Environment b. Domestic Conditions 3 Beyond 215 6

7 Korea Poland S. Africa Mexico Chile Turkey Peru China Indonesia India Russia Colombia Brazil Peru Korea Mexico Chile Russia Turkey Poland Brazil Indonesia Colombia India China S. Africa Since Mexico s economy is very open, the implementation of monetary policy is heavily influenced by external developments. Trade Openness Exports and Imports as % of GDP, Financial Openness Chinn-Ito Index 1/, Source: Own calculations with data from World Economic Outlook and Direction of Trade Statistics, IMF. 1/ Measures a country's degree of de jure capital account openness (-1 scale), based on the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). Source: Chinn and Ito (26) : "What Matters for Financial Development? Capital Controls, Institutions, and Interactions, JDE 81(1): (October). 7

8 The recent behavior of the world economy and its projected evolution for the rest of 214 and in 215 favors the expansion of Mexican exports. 2 Major Economies: Real GDP Index 4Q-27 = 1, s.a. 2Q Mexican Exports by Country of Destination % of Total, 213 Japan,.6 China, China United States Japan 14 1 U.K.,.4 Eurozone, 4.4 Canada, 2.8 Other, Eurozone United Kingdom 96 U.S., s.a./ Seasonally adjusted. Source: Haver Analytics. Source: INEGI. 8

9 I 213 II 213 III 213 IV 213 I 214 II 214 III 214 IV 214 I 215 II 215 III 215 IV 215 In particular, analysts estimate US GDP growth above potential. Gross Domestic Product Potential GDP 1/ US: Real Gross Domestic Product Quarterly annualized rate, s.a. Forecast s.a./ Seasonally adjusted. 1/ Mid-point of the central tendency interval of FOMC participants projections for the long-run change in real GDP. Sources: BEA, Federal Reserve and Blue Chip. 9

10 Corporate AAA Corporate BBB Corporate high yield* ABS MBS Agencies Corporate AAA Corporate BBB Corporate high yield* On the other hand, the expected increase in interest rates in the US will pose additional challenges for monetary policy in Mexico and other emerging market economies. Risks are enhanced by the continued search for yield Basis points Treasury notes 1/ Volatility indexes for selected financial assets Current (8-Oct-14) Percent S&P 5 2/ Currency index 3/ 1-year range Commodity index 4/ Source: Banco de México with data from Bloomberg 1/ MOVE (Merrill Option Volatility Estimate). 2/ VIX( CBOE Volatility Index ). 3/ CVIX: 3-month implicit volatility of the most operated currencies. 4/ Actual volatility of the CRB index (index composed of 19 commodity futures contracts) Yield to maturity of selected fixed income securities United States 23% 27% 1-year range Percent Source: Bank of America - Merrill Lynch. *Bonds with credit rating lower than BBB-. Europe Current (7-Oct-14)

11 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 and the fact that markets seem to be overly optimistic about the pace of interest rate adjustments in the US. Federal Funds Rate Futures and FOMC Projections % FFR Futures 3-Jun-14 FFR Futures 8-Oct-14 Median FOMC Mar-14 Median FOMC Dec-13 Median FOMC Jun-14 Median FOMC Sep Federal Funds Rate Implicit in the OIS 1/ Curve and FOMC Projections % FFR implicit in OIS curve Median FOMC Dec-13 Median FOMC Mar-14 Median FOMC Jun-14 Median FOMC Sep Source: Bloomberg and FOMC Economic Projections. Source: FOMC s projections and own calculations with data from Bloomberg. 1/ Overnight Index Swap. 11

12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 However, it is important to note that markets have differentiated across countries. S. Africa Emerging Markets: Credit Default Swaps 1/ Index 1-Jan-213 = 1 Brazil 214 Russia Turkey Oct Peru Chile 11 Colombia Korea Poland Mexico / 5-year CDS. Source: Bloomberg, with data through 8 October

13 Outline 1 Introduction 2 Monetary Policy in a. The External Environment b. Domestic Conditions 3 Beyond

14 I-214 II-214 Economic activity showed clear signs of recovery during the first half of Real Gross Domestic Product Annual % and Quarterly Annualized Rate, s.a s.a./ Seasonally adjusted. Source: INEGI. 14

15 Exports were the main factor behind the expansion of economic activity, but a revival of domestic demand was also observed Aggregate Supply and Demand Quarterly %, s.a. 214-I 214-II GDP Imports Private Consumption Govt. Consumption Private Investment Govt. Investment Exports -8 s.a./ Seasonally adjusted. Source: Banco de México and INEGI. 15

16 which has continued in more recent months. Retail Sales Index 23=1, s.a. Jul 13 Imports of Consumption Goods 1/ and Domestic Sales of Light Vehicles Index 27 = 1 and Thousands of annualized units, s.a. 1,4 1,3 Aug Sep Gross Fixed Investment Index 28 = 1, s.a. Jul ,2 1,1 Imports of Consumption Goods Total , Domestic Sales of Light Vehicles Construction s.a. / Seasonally adjusted data. Source: Banco de México with data from INEGI. s.a. / Seasonally adjusted data. 1/ Excludes oil and automobile imports. Source: Banco de México and AMIA (Mexican Association of the Automobile Industry). s.a./ Seasonally adjusted data. Source: INEGI. 16

17 Nonetheless, substantial slack persists. National and Urban Unemployment Rates % of EAP, s.a. Urban Aug 8 7 Output Gap % of potential output, s.a. 2Q-14 July GDP IGAE -4-6 National EAP/ Economically Active Population. s.a./ Seasonally adjusted. Source: National Employment Survey (Encuesta Nacional de Ocupación y Empleo), INEGI. s.a./ Calculated with seasonally adjusted data. Note: The shaded area is the 95% confidence interval of the output gap. Source: Calculated by Banco de México with data from INEGI. 17

18 In the case of inflation, some upward pressures have been observed recently. Consumer Price Index Annual % Headline Sep Core Sources: Banco de México and INEGI. 18

19 However, they result from factors of a temporary nature, and are not demand-driven. Core Inflation Annual % Core Food, Beverage and Tobacco Air Transportation Sep Non-core Livestock Non-Core Inflation Annual % Sep Sources: Banco de México and INEGI. Sources: Banco de México and INEGI. 19

20 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Jan-1 Aug-1 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Consequently, medium and long term inflation expectations remain well anchored. Headline Inflation Expectations Median, % End of 214 End of 215 Next 4 and 5-8 Years Banco de México Sep Oct 4.5 Sep Oct 4.5 Sep Banco de México Next 4 Years Banamex 3.5 Banamex 3.5 Next 5-8 Years Sources: Banco de México s Survey, monthly. Last observation: September 214. Banamex Survey, bi-weekly. Last observation: 7 October

21 Looking forward: Strong external demand; Expansionary monetary policy; Fiscal stimulus; and Increasing levels of confidence. give support to Banco de México s expectation of 2-2.8% GDP growth in 214 and % in 215, implying an expansion above potential in 2H-214 and in

22 A strong cyclical upturn during the rest of this year and the next is expected to coincide with the convergence of inflation to the 3% target in 215 given: 1. A negative although gradually closing output gap. 2. Gasoline price increases based on inflation expectations. 3. A favorable base effect after the tax reform. 22

23 This scenario is subject to a number of risks: Uncertainty related to estimates of the output gap. Faster closing of the output gap if the recovery of economic activity is stronger than currently foreseen. Additional shocks deriving from the behavior of non-core inflation or other factors. 23

24 Monetary policy normalization in the US represents another risk for the Mexican economy. Increased financial market volatility and uncertainty. Tighter external financing. Potential impact on peso exchange rate and inflation. Risks have increased as the beginning of interest rate hikes draws closer. 24

25 The Mexican economy has solid macroeconomic and financial stability bases to resiliently sail through the process. Strong macroeconomic position: Credible monetary and fiscal policies. Flexible exchange rate regime. Low current account deficit. Record high international reserves. FCL with the IMF. Relatively low public debt. Financial stability in the context of enhanced policy framework. Favorable growth prospects after a major structural reform effort: Labor markets: November 212. Education: September 213. Financial sector: January 214. Competition: May 214. Telecommunications: July 214. Energy: August

26 Outline 1 Introduction 2 Monetary Policy in a. The External Environment b. Domestic Conditions 3 Beyond

27 Beyond 215 Inflation targeting has proved its merits in Mexico and other countries before, during and in the aftermath of the global financial crisis. However, the crisis has highlighted a number of issues whose implications for inflation targeting regimes will have to be carefully assessed. One of them is the need to better understand the role of monetary policy and other instruments in preserving financial stability. Nonetheless, this does not imply a substantial modification of the fundamental structure of these regimes, nor does it raise question marks on their usefulness to anchor inflation expectations. 27

28 Beyond 215, monetary policy is likely to operate in an environment characterized by world economic growth below that observed before the crisis... GDP Growth Projections Annual % 8 China United Kingdom United States Eurozone Japan 1-1 Source: IMF s World Economic Outlook, October

29 and an upward trend in international interest rates, which underlines the importance of strengthening the domestic sources of growth. Federal Funds Rate Annual % 4. Federal Funds Rate FOMC OIS-implied Futures Blue Chip Sources: FOMC, Bloomberg and Blue Chip. 29

30 CHE NOR TUR CZE USA FRA KOR AUS AUT BEL CHL DEU NLD SWE POL FIN JPN SVK CAN EST LUX SVN NZL ITA GRC HUN IRL ISR MEX PRT DNK GBR ESP Even before considering the key measures approved in 214 (financial, competition, telecommunications and energy), Mexico s efforts of structural reform were deemed to be among the most ambitious in the world. Contrary to other experiences, this was not propelled by an economic crisis. Economic Reform Responsiveness Share of OECD reform recommendations with significant action taken during Source: Own calculations based on results presented in OECD (214), Going for Growth Interim Report, February. 3

31 The latter should allow the economy to grow at faster rates without pressures on prices. More flexible and competitive product and input markets More efficient resource allocation More and better human and physical capital More incentives for technological change Stronger institutional framework Higher economic growth Productivity gains Lower inflationary pressures Main challenges: adequate implementation of structural reforms, tackling other major structural obstacles to growth, continuous strengthening of economic fundamentals. 31

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