April June August 1, 1
Outline 1 Monetary Policy External Conditions 5 Economic Activity in Mexico Inflation Determinants Forecasts and Balance of Risks
Monetary Policy Conduction Monetary policy has focused on reaching an efficient convergence towards the percent inflation target, i.e. at the lowest cost to economic activity. The process of anchoring inflation expectations has been one of the key factors for this convergence. Monetary policy conduction Anchoring of inflation expectations Low and stable inflation environment
Monetary Policy Conduction Inflation: developed as expected in the first half of the year, while inflation expectations for the end of and 015 declined. Economic activity: was less dynamic than expected in the first months of the year, resulting in a higher degree of slackness in the economy. In this context, considering: The favorable performance of inflation. The outlook that inflation will be close to percent from the beginning of 015 onwards. Anchored inflation expectations. The weakness of economic activity. The Board of Governors decided in June to decrease the Overnight Interbank Interest Rate from.5 to.0 percent.
The Board of Governors also estimated that, considering the foreseen recovery of the economy and the monetary stance of Mexico relative to the U.S., a further reduction of the interest rate target was not recommendable. 00 00 005 006 007 008 009 Overnight Interbank Interest Rate 1/ % 10 9 8 7 6 5 1/ Since January 1, 008, the Overnight Interbank Interest Rate is shown. Source: Banco de México. 5
Outline 1 Monetary Policy External Conditions 5 Economic Activity in Mexico Inflation Determinants Forecasts and Balance of Risks 6
External Conditions Global Outlook in Q Growth Recovery of the world economy: Advanced economies: the effects of a lower fiscal consolidation and a very accommodative monetary policy supported the recovery. Emerging economies: relatively weak conditions persisted. Inflation In general, remained at low levels. Monetary Policy Expectation that monetary stimulus in advanced economies prevails for a prolonged period. In particular, the U.S. Federal Reserve reaffirmed, conditional on the performance of the economy, its expectation of a gradual normalization of its monetary policy. 7
Growth of the world economy increased moderately during Q, after a weaker than expected onset of the year. World GDP Growth and Manufacturing Purchasing Managers Index (PMI) Quarterly % change at annual rate and diffusion index, s.a. Global PMI GDP July Q s.a./ Seasonally adjusted data. Note: The sample of countries used for the calculation represents 86.1% of global GDP measured by purchasing power parity. Source: Estimated by Banco de México with data from Haver Analytics, JPMorgan and Markit. 8
In the U.S., manufacturing production presented a solid growth and labor market conditions further improved. 007 008 009 007 008 009 Industrial and Manufacturing Production Index 007=100, s.a. Industrial production 110 105 100 11 10 9 8 Change in Nonfarm Payrolls and Unemployment Rate Thousands of jobs and % of EAP, s.a. Unemployment rate 600 00 00 95 7 0 Manufacturing production July 90 85 80 6 5 Change in nonfarm payrolls July -00-00 -600-800 s.a./ Seasonally adjusted data. Source: Federal Reserve. EAP/ Economically Active Population. s.a./ Seasonally adjusted data. Source: Bureau of Labor Statistics. 9
008 009 008 009 In the Euro zone, economic recovery remained weak and heterogeneous, with GDP still below pre-crisis levels. GDP Growth and Contributions of its Components as Compared with its Recent Peak % and percentage points, s. a. Government Private consumption Net Exports Gross Domestic Product Index I-008=100, s.a. Germany 1Q 106 10 10 0 - France Euro Zone 100 98 GDP Investment Inventories 1Q - -6-8 Italy Spain 96 9 9 90 s.a./ Seasonally adjusted data. Source: Eurostat and Haver Analytics. s.a./ Seasonally adjusted data. Source: Eurostat. 10
In the U.S., inflation increased, although it remains below the Federal Reserve s percent target. Meanwhile, in the Euro zone deflation risks persist. U.S.: Personal Consumption Expenditures Price Index Annual % change.5 Euro Zone: Consumer Prices Index Annual % change.5 Headline Headline.0.5.5.0 1.5 1.5 Core 1 Core 1.0 0.5 0.5 June 0 July 0.0 Source: Bureau of Economic Analysis. Source: Eurostat. 11
The U.S. Federal Reserve reaffirmed its strategy of gradually withdrawing the monetary stimulus. However, recent U.S. data have raised expectations among some market participants of an anticipated adjustment of monetary conditions in that country. 1990 199 199 1996 1998 000 00 00 006 008 Jun-1 Aug-1 Oct-1 Dec-1 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Interest Rates of Government Securities % Federal Funds Rate Futures % August 9 8 7 09-Jan-1 01-Jul-1 1/ 1-Aug-1.5.0 10 years 6 5 1.5 1.0 years 0.5 Federal Funds rate 1 0 0.0 Source: U.S. Department of the Treasury. 1/ Date prior to the publication of favorable economic activity data and the FOMC s July statement. Source: Bloomberg. 1
The expectation of a prevailing accommodative monetary policy intensified the search for yield process in Q, leading to a recovery of capital flows to emerging economies. Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Sep-1 Oct-1 Nov-1 Dec-1 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Accumulated Capital Flows to Emerging Markets (Debt and Equity) 1/ USD billion 0 0 0 Debt Equity 10 0-10 -0-0 August -0 1/ The sample includes funds used to sell or buy equity and bonds from emerging markets registered in advanced economies. Flows exclude changes in market value of portfolios and changes in foreign exchange rates. Source: Emerging Portfolio Fund Research. 1
Given the aforementioned, low volatility was registered in financial markets. However, due to more favorable than expected U.S. economic data, volatility increased recently. Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Sep-1 Oct-1 Nov-1 Dec-1 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Sep-1 Oct-1 Nov-1 Dec-1 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Volatility in FX Markets % Emerging 1/ 17 15 1 Nominal Exchange Rate against USD Index 01-Jan- = 100 Depreciation South Africa Turkey 1 18 1 10 11 Brazil Chile 116 11 9 Peru Colombia 108 10 Advanced / 7 5 Mexico Korea 100 96 9 1/ Simple average of the implied volatility of one month exchange rate put options for: Brazil, Chile, Korea, India, Mexico, Peru, Poland, South Africa and Turkey. / JP Morgan s FX implied volatility index for G7 countries (Canada, France, Germany, Italy, Japan, U.K. and U.S.). Source: Bloomberg. Source: Bloomberg. 1
In this context, Mexico stood out for being one of the economies whose risk indicators have been less affected during recent episodes of volatility. Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Sep-1 Oct-1 Nov-1 Dec-1 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Aug-1 Credit Default Swaps 1/ Index 01-Jan-=100 Brazil Turkey 0 10 190 170 150 South Africa Peru Chile 10 110 Colombia Mexico 90 70 50 1/ 5-year CDS. Source: Bloomberg. 15
Outline 1 Monetary Policy External Conditions 5 Economic Activity in Mexico Inflation Determinants Forecasts and Balance of Risks 16
Economic activity in Mexico improved during Q, as compared to the weakness observed in the previous two quarters. 008 009 008 009 Economic Activity Indicators Index 008 = 100, s.a. Industrial Activity Index 008 = 100, s.a. 160 150 10 10 Total IGAE Services IGAE Industrial production 118 11 110 106 Electricity Manufactures 15 10 115 110 10 110 10 Construction 105 100 100 98 95 90 80 Agricultural IGAE May June 9 90 Mining June 90 85 s.a./ Seasonally adjusted data. Source: Mexico s System of National Accounts (Sistema de Cuentas Nacionales), INEGI. s.a./ Seasonally adjusted data. Source: Mexico s System of National Accounts (Sistema de Cuentas Nacionales), INEGI. 17
007 008 009 007 008 009 007 008 009 More dynamic economic activity was mainly driven by external demand. Total Others 190 175 Manufacturing Exports Index 007=100, s.a. Automobile Others 0 10 Non-automobile Others 170 160 Total U.S. 160 15 10 115 100 85 Total U.S. 190 170 150 10 110 90 70 Total U.S. 150 10 10 10 110 100 90 80 June June June 70 50 70 s.a./ Seasonally adjusted data. Source: Banco de México. s.a./ Seasonally adjusted data. Source: Banco de México. s.a./ Seasonally adjusted data. Source: Banco de México. 18
007 Some consumption indicators changed their trend, although some of their determinants continue showing signs of weakness. 008 009 007 008 009 Monthly Indicator of Private Consumption in the Domestic Market and ANTAD Total Sales Index 008=100, s.a. 10 Consumer Confidence Index Jan-00=100, s.a. 115 ANTAD total sales Private consumption 15 10 115 110 105 100 95 110 105 100 95 90 85 80 May July 90 85 July 75 70 s.a./ Seasonally adjusted data. Source: Estimated by Banco de México with data from INEGI and ANTAD. s.a./ Seasonally adjusted data. Source: Banco de México and INEGI. 19
007 008 009 007 008 009 Gross fixed investment indicators gradually improved in Q. Investment and its Components Index 008=100, s.a. Real Value of Production in Construction Index Jan-008=100, s.a. Machinery and equipment 10 10 10 Public Private excluding housing May 10 10 10 110 Total 110 100 Total Private 100 90 80 Construction 90 80 Privada housing 70 60 50 May 70 0 s.a./ Seasonally adjusted data. Source: INEGI. s.a./ Seasonally adjusted data. Source: INEGI and seasonally adjusted by Banco de México in the case of public and private construction (private housing and private excluding housing). 0
007 008 009 007 008 009 007 008 009 Despite the more dynamic economic activity, during Q slack conditions persisted in the labor market. National Unemployment Rate % of EAP, s.a. 7 Total IGAE, IMSS-insured Workers and Employed Population Index =100, s.a. 109 Labor Informality Rate % of employed population, s.a. 6 6 IMSS-insured workers 1/ Total IGAE 106 10 61 60 5 Employed population 100 97 59 9 58 June May July 1Q 91 88 85 June 57 56 55 EAP/ Economically Active Population. s.a./ Seasonally adjusted. Source: National Employment Survey (Encuesta Nacional de Ocupación y Empleo), INEGI. a.e./ Cifras con ajuste estacional. 1/ Permanent and temporary workers in urban areas. Source: IMSS and INEGI (SCNM and ENOE). Seasonally adjusted by Banco de México except for IGAE. s.a./ Seasonally adjusted. Source: Calculated and seasonally adjusted by Banco de México with data from the National Employment Survey (Encuesta Nacional de Ocupación y Empleo), INEGI. 1
I 007 I 008 I 009 I I I I I I-199 I-1996 I-1999 I-00 I-005 I-008 I- I- Although labor productivity in the manufacturing sector continued its upward trend, the one corresponding to the whole economy has remained stable in the last years. Productivity and Unit Labor Cost in the Economy Index 008=100, s. a. Productivity 1/ 105 10 101 Total Factor Productivity and Labor Productivity in the Economy and in the Manufacturing Sector / Indices IV-006=100, s. a. Total factor productivity 10 110 99 100 Unit labor cost 97 95 9 91 89 87 Labor productivity in the manufacturing sector Labor productivity in the economy 90 80 70 60 1Q 85 1Q 50 s.a./ Seasonally adjusted and trend data. 1/ Productivity based on the amount of hours worked. Source: Unit cost prepared by Banco de México based on data from INEGI. The Global Index of Labor Productivity in the Economy (IGPLE), as released by INEGI. s.a./ Seasonally adjusted and trend data. / The total factor productivity was estimated as the Solow residual of a regression in logs of GDP versus labor and capital stock. Labor productivity is based on the amount of hours worked. Source: Prepared by Banco de México with data from IGPLE, EMIM and industrial activity data from Mexico s System of National Accounts (Sistema de Cuentas Nacionales), INEGI.
Outline 1 Monetary Policy External Conditions 5 Economic Activity in Mexico Inflation Determinants Forecasts and Balance of Risks
The conduction of monetary policy, among other factors, contributed to the decrease in annual headline inflation in Q. Later, as expected, an increase was observed, mainly due to a low base of comparison. Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-1 Jul-1 Jan-1 Jul-1 Jan-1 Jul-1 Consumer Price Index Annual % change 1 1 Non-core 11 10 9 8 Headline 7 6 Variability interval Core 5 1 Source: Banco de México and INEGI.
Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-1 Jul-1 Jan-1 Jul-1 Jan-1 Jul-1 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-1 Jul-1 Jan-1 Jul-1 Jan-1 Jul-1 Although an important number of fiscal modifications that came into force in affected the core price index, its annual change kept close to percent. Core Price Index Annual % change Merchandise 10 9 Services 8 7 Food, beverages and tobacco 8 7 Education (tuiton) 6 5 Merchandise 6 5 Services Housing 1 Non-food merchandise 1 Other services 0-1 0 - Source: Banco de México and INEGI. Source: Banco de México and INEGI. 5
Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-1 Jul-1 Jan-1 Jul-1 Jan-1 Jul-1 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-1 Jul-1 Jan-1 Jul-1 Jan-1 Jul-1 In Q, non-core inflation was lower than at the beginning of the year, although it increased recently due to arithmetic effects of a low base of comparison in the agricultural price subindex. Non-core Price Index Annual % change Agricultural Livestock Fruits and vegetables Agricultural 0 7 1 18 15 1 9 6 0 - -6-9 -1-15 Energy and Government Approved Fares Gasoline Energy and government approved fares 16 1 1 10 8 6 0 Source: Banco de México and INEGI. Source: Banco de México and INEGI. 6
Due to the evolution of economic activity in 1Q, the output gap widened and, despite the foreseen recovery, it is expected to remain negative until the end of 015. 00 005 006 007 008 009 Output Gap 1/ % of potential output, s.a. 8 6 IGAE GDP 0-1Q May - -6-8 -10-1 -1 s.a./ Calculated with seasonally adjusted data. 1/ Estimated using the Hodrick-Prescott (HP) filter with tail correction method; see Banco de México (009), Inflation Report April June 009, p.69. The shaded area is the 95% confidence interval of the output gap, calculated with an unobserved components method. Source: Calculated by Banco de México with data from INEGI. 7
005 006 007 008 009 Long-term inflation expectations implicit in market instruments have gradually declined, while those obtained from surveys remain at.5 percent. Break-even Inflation Decomposition 1/ % Annual Headline Inflation Expectations Median, % Break-even inflation implicit in 10-year bonds.6 7.0 5.0 Long term inflation expectation Inflationary risk premium. 0.1 6.0.5 July 5.0.0 Next years Next 5-8 years End of End of 015.0.5.0.0.0.5 Variability interval 1.0.0 0.0 July 1.5 1/ The inflation risk premium is calculated with an affine model as described in Aguilar, Elizondo and Roldán () with data from Valmer and Bloomberg. Source: Banco de Mexico s Survey. 8
007 008 009 007 008 009 Reflecting the decrease in the reference interest rate, interest rates and spreads between U.S. and Mexican long-term interest rates decreased. Interest Rates of Government Securities 1/ % 10 years August 0 years 1 11 10 9 8 7 6 5 Spread between Mexico and U.S. Interest Rates Percentage points 6 months 0 years August 8.5 7.5 6.5 5.5.5.5 6 months 1 day 10 years 1 day.5 1.5 1/ Since January 1, 008, the overnight interest rate corresponds to the target for the Overnight Interbank Interest Rate. Source: Banco de México and Proveedor Integral de Precios (PiP). Source: Banco de México, Proveedor Integral de Precios (PiP) and U.S. Department of the Treasury. 9
Mar-1 Jun-1 Sep-1 Dec-1 Mar-15 Jun-15 Sep-15 Dec-15 Thus, the yield curve shifted downwards and the expected short-term interest rates for and 015 decreased. Government Bond Yield Curve % 0-Dec-1 8.0 7.5 7.0 Expectations for the Overnight Interbank Interest Rate % 5.0.5 1-Mar-1 11-Aug-1 6.5 6.0 5.5 5.0.5.0 Observed May June July.0.5.0.5.5.0 1 1 6 1 5 10 0 0.5.0 Day Months Years Source: Banco de México and Proveedor Integral de Precios (PiP). Source: Banco de México survey. 0
Outline 1 Monetary Policy External Conditions 5 Economic Activity in Mexico Inflation Determinants Forecasts and Balance of Risks 1
Economic Activity Outlook 9 8 7 6 5 1 0-1 - - - -5-6 -7-8 -9 GDP Growth Between.0 and.8% 015 Between. and.% GDP Growth Annual %, s.a. s.a./ Seasonally adjusted data. Source: INEGI and Banco de México. Q Q 015 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 008 015 Fan Charts 9 8 7 6 5 1 0-1 - - - -5-6 -7-8 -9 Increase in the number of IMSS-insured workers 7 6 5 1 0-1 - - - -5-6 -7 Between 570 and 670 mil 015 Between 60 and 70 mil Output Gap % of potential output, s.a. s.a./ Elaborated with seasonally adjusted data. Source: Banco de México. Q Q 015 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 008 015 7 6 5 1 0-1 - - - -5-6 -7
Risks to the Growth Outlook: Upward: The possibility of a better than expected implementation of structural reforms with its consequent impact on investors and economic agents expectations. The possibility of a more vigorous than expected recovery of U.S. economic activity. Downward: Economic agents confidence might recover more slowly than anticipated, which would delay a full recovery of domestic demand.
015 Inflation Forecasts Headline inflation Core inflation Second half of : it is expected to remain close to percent, although it could exceed that level at some point, as happened in July. End of : it is anticipated to lie below percent, as the effects of relative price changes from November and December vanish. It is anticipated to remain close to percent in the rest of. It is estimated to reduce to levels close to percent at the beginning of 015 and to stay around that level for the remaining of the year. It is expected to be below percent in 015.
The fading of the effect of the relative price changes and the expectation that the increments in gasoline prices will be in line with expected inflation, will contribute to the decrease in inflation in 015. 7.0 6.5 6.0 5.5 5.0.5.0.5.0.5.0 1.5 1.0 0.5 0.0 Annual Headline Inflation 1/ % Observed Headline inflation target Variability interval 015 Q Q Q Fan Charts 7.0 6.5 6.0 5.5 5.0.5.0.5.0.5.0 1.5 1.0 0.5 Annual Core Inflation / % 0.0 0.0 QQQQQQQQQQQQQQQQQQQQ QQQQQQQQQQQQQQQQQQQQ 006 008 015 006 008 015 7.0 6.5 6.0 5.5 5.0.5.0.5.0.5.0 1.5 1.0 0.5 Observed Headline inflation target Variability interval 015 Q Q Q 7.0 6.5 6.0 5.5 5.0.5.0.5.0.5.0 1.5 1.0 0.5 0.0 1/ Quarterly average of annual headline inflation. Source: INEGI and Banco de México. / Quarterly average of annual core inflation. Source: INEGI and Banco de México. 5
The inflation outlook might be affected by certain risks: Downward Upward The possibility of a lower than expected recovery of the Mexican economic activity. New episodes of volatility in international financial markets that imply exchange rate adjustments, which in turn may affect inflation (moderately and transitorily). 6
Monetary Policy Stance Banco de México s Board of Governors considers that the monetary policy is consistent with the efficient convergence of inflation to its percent target. However, the Board will closely monitor the performance of the inflation determinants and the medium- and long-term inflation expectations, including the foreseen recovery of the economy and the monetary policy stance of Mexico relative to the U.S., in order to provide the necessary conditions to reach the percent target of headline inflation. 7
The completion of the legislative stage of the structural reform process, aimed at increasing the country s productivity, is encouraging. The recent approval of the secondary legislation of the economic competition, telecommunications and broadcasting and energy reforms is an indispensable step in the right direction. Thus, these reforms are expected to: Boost the economy s competitiveness. Have a positive and sustainable impact on employment, wages, potential growth and investment climate. The increase in productivity would allow reaching higher aggregate demand and supply growth rates without generating inflationary pressures. The latter will be more likely given that the mentioned reforms were achieved in an environment of macroeconomic stability. In the future, despite the great progress made, it is still imperative to encourage an adequate implementation of the reforms. 8