Mexico - Economic Briefing October 2004

Central Bank Continues to Tighten Policy (continued)

Consensus increasingly optimistic owing to pickup in U.S. economy
Consensus Forecast panellists are increasingly optimistic about growth prospects for this year, as the second quarter soft patch observed in the U.S. economy is likely to give way to more robust growth in the second half, which should provide a solid backdrop for a recovery in Mexico.  Panellists believe the economic growth will accelerate from 3.8% growth in the first half to 4.2% in the second half.  For the full year, Consensus Forecast panellists expect the economy to expand by 4.0%, which is up another notch from last month’s forecast, following on upward revisions in the previous five months.  Moreover, the Consensus is increasingly optimistic about next year’s growth prospects and has lifted its 2005 GDP growth forecast from 3.5% expected last month to 3.7%.

Inflation continues to rise
In September, consumer prices increased 0.83%.  The actual rate was well above the 0.61% increase expected in last month’s Consensus Forecast.  Higher prices for fresh fruits and vegetables constituted the main drivers behind the September increase.  Fresh fruits and vegetables prices rose due to shortages induced by excessive rainfall.  The September price spike pushed annual headline inflation from 4.8% in August to 5.1%, the highest rate registered since April 2003.  The majority of the September price increase was concentrated in the price categories that experience more erratic shifts and are not included in the core inflation index.  Thus, the core inflation index increased by only 0.26% over August.  Consequently, annual core inflation increased by only 0.1 percentage points over August to 3.8%.  Thus, even though headline inflation now exceeds the upper limit of the Central Bank’s one percentage point tolerance around a 3.0% central target rate by more than a full percentage point, the core inflation rate is still within the established limits.

Central Bank tightens monetary policy to stem inflation rise
Nevertheless, on 24 September, the Central Bank decided to raise its money market "short" (corto) to 51 million pesos per day from 45 million pesos.  An increase in the corto reduces overnight lending to banks and indirectly drives up interest rates.  This was the sixth time this year that monetary authorities have acted to stem rising inflationary expectations. Markets had widely expected a tightening of monetary policy, but were surprised by the magnitude since on previous moves this year the Central Bank had raised the corto by intervals of just 4 million pesos.  This was the case in the last move on 27 August, when the Central Bank raised the corto to 45 million pesos per day from 41 million pesos.  Despite continued monetary tightening, Consensus Forecast panellists have lifted their forecasts for inflation over last month.  Panellists see year-end inflation at 4.3%, up one tenth of a percentage point compared to last month’s forecast.  The forecast for 2005, also increased a notch to 3.9%.  In its recent biannual monetary policy report, the Central Bank reiterated its 3.0% target for headline inflation but acknowledged that it had underestimated the scope and duration of key price drivers, such as the persistent oil price increase.