Economic growth continues at an unrelenting pace driven by all sectors of the economy.  While inflation keeps declining, the Central Bank is tightening its stance to counter the ever-increasing domestic demand and to keep inflationary expectations in line with its medium-term inflation target.  This is a two edged sword however since higher interest rates will firm the peso, which, in turn, may further boost the growing trade deficit, which is beginning to raise concerns.

Economy keeps growing strongly.  On 26 July, the National Statistical Institute (INEGI) released its new monthly indicator (IGAE, Indicador Global de la Actividad Económica) that tracks the economic activity in Mexico.  According to the new index, GDP expanded 8.5% in May compared with the same month last year.  The May reading was reflected across all sectors and illustrates the continued strength of the domestic economy:  Investment experienced a strong surge in May, growing 13.4% over the same month last year, driven mainly by investment in machinery and equipment (+18.7% year-over-year) whereas construction lagged behind, expanding by 7.6% over May 1999.  The surge in investment, which significantly exceeded market expectations of 9-12%, should help ease fears that strong domestic demand is exerting undue pressure on prices.  Consumption also was a solid driver of economic growth.  In May, retail sales increased 12.5% over the same month last year, up from 11.2% year-over-year growth registered in April.  In addition to strong investment and consumption growth, the external sector continues to play an important part in economic growth.  In May, exports increased a whopping 33.1% over May 1999.  In the light of the upward surprises panellists have further revised their 2000 growth projections.  The expected slowdown in the US economy in the coming year, however, will also slow the pace of economic expansion in Mexico.

Industrial expansion slowing down as expected.  On 11 August, INEGI announced that June industrial production increased 7.2% over the same month last year.  The June performance remained well below the strong May reading of 9.0% and somewhat below market expectations, which were around 7.5%.  As in the past, the maquiladora (in-bond manufacturing) industry was the main driver behind the expansion, however, at a much slower pace (+11.8% yoy) than last month (+16.4% yoy).

Inflation falling further.  In July, consumer prices increased 0.39% over June 2000.  This was the lowest July rate registered in the last 28 years and below market expectations of 0.45%.  As a result, the annual inflation rate dropped to 9.1% after 9.4% registered in June, the lowest rate since the outbreak of the Peso Crisis in December 1994.  In July, fuel prices provided for some upward pressure, partly compensated by drops in housing and vegetable prices.

Interest rates rise on tighter monetary policy.  Despite the positive inflationary developments, the Central Bank is concerned over the possible build up of inflationary pressures owing to the robust domestic demand.  In order to counteract these pressures and to maintain inflationary expectations in line with its 3% inflation target for 2003, the Bank increased the so-called “short” for the fourth time this year on 31 July.  The “short” restricts credit to banks and helps drive up interest rates.  As a result, rates on the benchmark 28-day Cetes, which had dropped to 13.4% in mid-July rose to 15.2% on 10 August.  However, despite the fact that the Central Bank tightened more than in previous adjustments, volatility in the secondary market also shot up, indicating that the market remains doubtful that interest rates will stay at their current levels.

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