Recent Economic Developments and Monetary Policy in Mexico Javier Guzmán Calafell, Deputy Governor, Banco de México* United States-Mexico Chamber of Commerce, Northeast Chapter New York City, 2 June 2017 */ The opinions and views expressed in this document are the sole responsibility of the author and do not necessarily represent the institutional position of the Banco de México or of its Board of Governors as a whole.
The most recent projections foresee a gradual upturn in world GDP growth starting this year. World GDP Growth Annual % Forecast 6 5 4 3 2 1 0-1 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: IMF, WEO October 2016 (dashed line) and April 2017 (solid line). Recent Economic Developments and Monetary Policy in Mexico 2
Particularly noteworthy are the improved prospects for the advanced economies Advanced Economies GDP Growth Annual % 3.0 3.0 United States Euro Area Forecast 2.5 Japan United Kingdom Forecast 2.5 2.0 2.0 1.5 1.0 1.5 0.5 1.0 2015 2016 2017 2018 0.0 2015 2016 2017 2018 Source: IMF, WEO October 2016 (dashed line) and April 2017 (solid line). Recent Economic Developments and Monetary Policy in Mexico 3
and the upturn in global industrial production and international trade. 58 Global Manufacturing PMI 1/ and Merchandise Trade Volume 2/ Diffusion Index and Annual % Change, s.a. <- Manufacturing PMI 20 56 Merchandise Trade -> 15 54 10 52 5 50 0 March April 48 2010 2011 2012 2013 2014 2015 2016 2017 s.a./ Seasonally adjusted data. 1/ Purchasing Managers Index. 2/ Sum of exports and imports. Source: Markit and CPB Netherlands. Recent Economic Developments and Monetary Policy in Mexico 4-5
Meanwhile, commodity prices have displayed a moderate recovery. Commodity Prices Index 2005 = 100 Oil Prices US Dollars per Barrel 275 125 250 225 200 Futures 1/ 115 105 95 85 Total Energy Industrial Metals Food April 175 150 125 100 75 50 WTI Mexican Oil Basket 75 65 55 45 35 25 15 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: IMF. 1/ As of 31 May 2017. Source: Bloomberg. Recent Economic Developments and Monetary Policy in Mexico 5
In the US, after having decelerated in early 2017, GDP growth appears to be strengthening, in a trend that is expected to continue over coming quarters. 1.8 1.5 1.2 0.9 Real Personal Consumption Expenditures and New Orders of Durable Goods 3-Month % Change, s.a. <- Real Personal Consumption Expenditures New Orders of Durable Goods -> United States 12 10 8 6 Gross Domestic Product Annualized Quarterly % Change, s.a. 4 3 0.6 0.3 4 2 2 0.0 0-0.3-2 1-0.6-4 -0.9 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 April -6 I II III IV I II III IV I II III IV I II III IV 2015 2016 2017 2018 0 s.a./ Seasonally adjusted data. Source: Bureau of Economic Analysis and Census Bureau. s.a./ Seasonally adjusted data. Source: Bureau of Economic Analysis and Blue Chip. Recent Economic Developments and Monetary Policy in Mexico 6
Industrial production in the US is expected to resume a positive rate of growth this year, in the context of a more dynamic external sector. United States Industrial Production Real Exports and Imports of Non-Petroleum Goods Annualized Quarterly % Change, s.a. Index 2012 = 100, s.a. 4 124 3 Exports Imports 120 2 116 1 0 112-1 108-2 104-3 100 I II III IV I II III IV I II III IV I II III IV 2015 2016 2017 2018-4 March 2012 2013 2014 2015 2016 2017 96 s.a. / Seasonally adjusted data. Source: Federal Reserve and Blue Chip. s.a. / Seasonally adjusted data. Source: Census Bureau. Recent Economic Developments and Monetary Policy in Mexico 7
In spite of a number of positive developments, a high level of uncertainty regarding the future evolution of the world economy persists, as a result of a number of factors. Globally, the main concerns gravitate around: o UK exit from the European Union. o Potential strengthening of protectionist and anti-globalization trends. o Macroeconomic and financial vulnerabilities in China and other emerging economies. o Latent likelihood of conflicts and difficulties of a geopolitical nature in some regions. In the US, the main sources of uncertainty arise from: o Insufficient clarity in relation to future actions from the part of that country s administration in several areas, notwithstanding the improvement observed recently. o The normalization of monetary policy by the Federal Reserve. Recent Economic Developments and Monetary Policy in Mexico 8
Economic activity in Mexico during the first quarter of 2017 was stronger than anticipated. Mexico: Gross Domestic Product % Change, s.a. 1.4 <- Quarterly Annual -> 1Q 3.5 1.2 3.0 1.0 2.5 0.8 2.0 0.6 1.5 0.4 1.0 0.2 0.5 0.0 2014 2015 2016 2017 0.0 s.a./ Seasonally adjusted data. Source: INEGI. Recent Economic Developments and Monetary Policy in Mexico 9
145 130 On the demand side, consumption keeps showing a significant year-over-year expansion, although decelerating at the margin, while investment expenditure has weakened further and exports continued to display an upturn. Domestic Consumption Index 2008=100; s.a. <- Antad Sales Private Consumption -> Retail Sales -> 130 120 Gross Fixed Investment Index 2008=100, s.a. Imported Machinery and Equipment Total Construction Domestic Machinery and Equipment 175 160 145 Manufacturing Exports Index 2008 = 100; s.a. 175 160 145 115 110 130 130 100 100 115 115 100 100 85 70 2008 2009 2010 2011 2012 2013 2014 2015 February March April 2016 2017 90 80 2007 2008 2009 2010 2011 2012 2013 2014 February 2015 2016 2017 85 70 2008 2009 2010 2011 2012 2013 2014 2015 2016 April 2017 85 70 s.a. / Seasonally adjusted data. Source: INEGI and ANTAD. s.a. / Seasonally adjusted data. Source: INEGI. s.a. / Seasonally adjusted data. Source: Banco de México, INEGI, SAT and SE. Recent Economic Developments and Monetary Policy in Mexico 10
An equivalent pattern is observed among the components of aggregate supply, as illustrated by the expansion of the services sector, with a recent deceleration, and the stagnation of industrial activity, although with an upward trend in manufacturing. Global Indicator of Economic Activity (IGAE) Index 2008=100, s.a. Total Industrial 130 125 120 Industrial Activity Index 2008=100, s.a. Total Mining Utilities Construction Manufacturing 140 130 120 Servicies 115 110 110 105 100 100 90 95 80 March 90 March 70 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 s.a. / Seasonally adjusted data. Source: INEGI. s.a. / Seasonally adjusted data. Source: INEGI. Recent Economic Developments and Monetary Policy in Mexico 11
Output Gap 1/ % of Potential; s.a. 8 Notwithstanding a better than expected performance during the first quarter, GDP growth is anticipated to decelerate during the rest of the year. Slack in the economy seems to have virtually disappeared. However, the weakening of economic activity should limit the emergence of demand pressures in coming months. 2006 2007 2008 2009 2010 2011 2012 s.a. / Seasonally adjusted data. 1/ The shaded area indicates the 95% confidence interval. Source: Banco de México with data from INEGI. Recent Economic Developments and Monetary Policy in Mexico 12 2013 2014 2015 IGAE GDP 2016 March 1Q-17 2017 6 4 2 0-2 -4-6 -8-10
A number of factors play a role in the economy s deceleration: o The impact on private consumption of the decline in real wages and low levels of consumer confidence. o Uncertainty may continue weighing down on confidence of the corporate sector, with adverse implications for investment. On the other hand, given the expectation of a further strengthening of industrial production, including manufacturing, in the US, Mexican exports should continue to recover. Recent Economic Developments and Monetary Policy in Mexico 13
Projections for economic growth in 2017 and 2018 have been adjusted downwards, although with a recent improvement in the case of the former. Real GDP Growth Forecasts Annual % 4.5 2017 2018 4.0 3.5 3.0 2.5 Banco de México s Forecast 2017 1.5 2.5 2.0 1.5 2018 1.7 2.7 May 1.0 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Source: Banco de México. Recent Economic Developments and Monetary Policy in Mexico 14
Price growth has increased significantly during 2017. Both headline and core inflation have trended upwards, recording higher-than-expected levels. CPI Inflation Annual % 12 Headline Core Non-Core 10 8 6 Variability Interval 4 2 May 1/ 0 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 1/ Data through the first fortnight of May. Source: INEGI. Recent Economic Developments and Monetary Policy in Mexico 15
Over the course of this year, headline inflation has been well above the upper limit of the variability interval around the permanent target of 3 percent. This, mainly as a result of the combined impact of a number of factors: o The adjustment of energy prices o A more evident pass-through from the exchange rate to prices. o Higher agricultural prices. o The increase in the minimum wage. o Rises in public transport fares. Recent Economic Developments and Monetary Policy in Mexico 16
The share of CPI items recording annual price growth above 4 percent has continued to increase, reaching around 60 percent through the first fortnight of May. Below 2% Between 2 and 4% Over 4% Lower than or equal to 3% Percentage of CPI Basket according to Intervals of Annual Increments % Headline 100 75 Below 2% Between 2 and 4% Over 4% Lower than or equal to 3% Core 100 75 50 50 25 25 May 1/ May 1/ 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 1/ Data through the first fortnight of May. Source: Banco de México and INEGI. Recent Economic Developments and Monetary Policy in Mexico 17
Inflation is expected to continue rising in the near future, before starting to decline in the second semester of this year, and at a faster pace in 2018. This, mainly as a result of the monetary policy adjustments implemented since late 2015, which have yielded an accumulated 375 basis-point increase in the reference interest rate. Monetary Policy Rates % 4.5 4.0 3.5 3.0 2.5 2.0 <- US (Federal Funds Rate)* Mexico (Overnight Interbank Interest Rate) -> Memo: Mexico's Headline CPI Annual Inflation -> 9 8 7 6 5 4 1.5 1.0 Inflation Variability Interval 3 2 0.5 May 1/ 0.0 June 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1/ Data through the first fortnight of May. */ Mid-pointofthe target range from 16 December 2008 onwards. Source: Banco de México, INEGI and Federal Reserve. Recent Economic Developments and Monetary Policy in Mexico 18 1 0
In addition, the decline in inflation will be influenced by: o The gradual fading of the shocks that have affected price growth. o The deceleration of economic activity. o The recent appreciation of the peso. o Base effects. Recent Economic Developments and Monetary Policy in Mexico 19
Survey-based inflation expectations display a pattern consistent with this trajectory. Nonetheless, inflation expectations for 2017 have increased significantly, while those for end-2018 remain at levels above the target. Short-Term Inflation Expectations Annual % 6.0 2017 2018 5.5 5.0 4.5 4.0 3.5 May 3.0 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Source: Banco de México. Recent Economic Developments and Monetary Policy in Mexico 20
Survey-based inflation expectations for the long term have remained stable around 3.5 percent. Long-Term Inflation Expectations 1/ Annual % 3.75 3.50 3.25 Permanent Target 3.00 2014 2015 2016 2017 1/ Median expectation for the next 4-8 years. Source: Banco de México. Recent Economic Developments and Monetary Policy in Mexico 21 May 2.75
Inflation breakevens have displayed a volatile behavior throughout the year, remaining at relatively high levels. Inflation Breakevens 1/ Basis Points 3 Years 10 Years 30 Years 510 475 440 405 370 335 300 265 Jan-16 Feb-16 Apr-16 Jun-16 Aug-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 1/ Difference between yields on nominal and real (inflation-protected) bonds. In addition to expected inflation, this measure includes other (e.g. inflationary, liquidity and term) risk premia. Source: Banco de México with information from PiP. Recent Economic Developments and Monetary Policy in Mexico 22 May 230
The balance of risks for inflation during this and next year remains tilted to the upside. So far, there is no evidence of second round effects on inflation. o Long-term inflation expectations remain stable. o Even though services inflation has increased, this responds mainly to cost effects derived from higher energy prices, a slower decline in telecommunications prices, and seasonal factors. Nonetheless, in light of the adverse inflation results and the multiplicity of shocks that have contributed to this outcome, the risk of second round effects has increased. To this, one may add the possibility of: o Further pressures on the exchange rate. o A higher pass-through coefficient. Recent Economic Developments and Monetary Policy in Mexico 23
The exchange rate of the peso vis-à-vis the US dollar has displayed a favorable behavior during 2017, and particularly since mid-january. 19-Jan-17 Source: Bloomberg. 10-Feb-17 Nominal Exchange Rate with Respect to the US Dollar Index 19-Jan-2017 = 100 04-Mar-17 26-Mar-17 17-Apr-17 Recent Economic Developments and Monetary Policy in Mexico 24 09-May-17 May 31-May-17 106 104 102 100 98 96 94 92 90 88 86 84 82 Chile Brazil Canada Norway Colombia Japan United Kingdom Euro Area Korea Turkey Poland Mexico
However, the peso-dollar rate remains highly sensitive to developments in a number of fronts, and especially to the likely evolution of the Mexico-US economic relationship. In light of the above, and in presence of other risk factors, both domestic and external, the potential for sharp swings in the peso exchange rate in coming months remains. It is also important to take into account that in view of the accumulated depreciation of the peso since September 2014, the possibility of lagged effects on prices cannot be ruled out. Sep-14 Consumer Prices and Peso-Dollar Exchange Rate Index September 2014 = 100 Exchange Rate CPI CPI Trajectory at 3% Annual Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May 1/ May-17 170 160 150 140 130 120 110 100 90 1/ CPI data through the first fortnight of May. Source: INEGI and Banco de México. Recent Economic Developments and Monetary Policy in Mexico 25
Domestic medium- to long-term interest rates, as well as their differential with respect to those in the US, have declined during the course of 2017. Domestic Interest Rates Level (%) Differential with Respect to US (%-Points) 8.0 6.5 30-Dec-16 31-May-17 30-Dec-16 31-May-17 7.5 6.0 7.0 6.5 5.5 6.0 5.0 1 1 3 6 9 12 2 3 5 7 10 20 30 5.5 1 1 3 6 12 2 3 5 7 10 20 30 4.5 Day Months Years Day Months Years Source: Banco de México and PiP. Source: Banco de México, PiP andus Department of the Treasury. Recent Economic Developments and Monetary Policy in Mexico 26
Mexico s credit default swaps have more than reverted their increase following the end of last year s electoral process in the US, although they remain above those of other economies with similar credit ratings. Emerging Market Economies: Credit Default Swaps 1/ Index 08-Nov-2016 = 100 140 130 120 110 100 Korea Peru Brazil Poland 90 80 70 S. Africa Mexico Chile 08-Nov-16 07-Dec-16 05-Jan-17 03-Feb-17 04-Mar-17 02-Apr-17 01-May-17 May 30-May-17 60 50 Turkey Colombia Thailand 1/ 5-year CDS. Source: Bloomberg. Recent Economic Developments and Monetary Policy in Mexico 27
Therefore, monetary policy in Mexico faces a scenario with mixed features: o Indications that economic activity is decelerating. o Low likelihood of demand pressures on prices. o Stable long-term inflation expectations. But at the same time: o Inflation performance above expectations. o A generalization of pressures on prices. o A probably higher pass-through from the exchange rate to prices. o Increased upside risks. Recent Economic Developments and Monetary Policy in Mexico 28
Furthermore, the most likely setting for coming months includes: o An inflation rate significantly above the upper limit of the variability interval around Banco de México s target for the rest of the year. o New hikes in the US federal funds rate. o An environment of high uncertainty, with potential implications for the exchange rate and prices. Recent Economic Developments and Monetary Policy in Mexico 29
Under these circumstances, a cautious monetary policy stance is needed, since otherwise second round effects on prices may emerge, with the credibility of monetary policy affected. This points to the probability of higher interest rates in Mexico in coming months. The margins of maneuver for monetary policy should widen as convergence of inflation towards the target becomes evident. The latter should be reinforced by continuous consolidation of the fiscal effort underway. Recent Economic Developments and Monetary Policy in Mexico 30